Spillovers from equity to banking markets : Evidence from stock liquidity and the cost of bank loans

We use the SEC Tick Size Pilot Program to show that stock liquidity reduces the cost of bank loans. Treated firms experience a 52 basis point increase in the cost of borrowing during the Tick Size Pilot Program; an effect that reverses when the program ends. We find similar results in a broad panel of firms using both retail and institutional measures of liquidity. We identify three non-mutually exclusive channels driving this effect. Liquidity increases the informativeness of prices, enhances external monitoring of the borrower by blockholders, and weakens the holdup problem in relationship banking. Finally, we show that firms respond to lower borrowing costs by using more bank credit