Institutional Dual Holdings and Expected Crash Risk : Evidence from Mergers between Lenders and Equity Holders

Exploiting mergers between lenders and shareholders of the same firm as an exogenous shock to dual ownership, we examine the role that dual holdings (i.e., simultaneous equity and debt holding) play in shaping firms’ ex ante expected stock price crash risk evident in the options implied volatility smirk. Given their privileged access to information as lenders and their double stakes, dual holders have both an information advantage and stronger monitoring incentives relative to other investors. We find that firms’ ex ante expected crash risk subsides after the shareholder-creditor merger. Consistent with expectations, we find strong, robust evidence that the negative impact of mergers on firms’ expected crash risk rises when the stakes that the institutional investors or lenders hold in the treatment firms are larger. We also find that expected crash risk decreases more subsequent to mergers in firms suffering worse asymmetry evident in fewer corporate disclosures (e.g., management earnings forecasts and 8-K filings) and more diverse analyst earnings forecasts. The impact is also generally concentrated in firms with lax internal or external monitoring mechanisms (evident in less independent boards and audit committees, poor internal controls, the absence of specialist auditors, less extensive analyst coverage, a lower takeover threat, and lower institutional ownership). Additionally, we show that our main finding is unlikely to be driven by indirect effects through shifts in financing or payout policies documented in prior research. Our results suggest that option market participants perceive the dual holding as a strong indication of the low expected crash risk of the underlying stock