Essays on small business lending

The focus of the dissertation is on information issues in small business lending. The first essay is a theoretical essay about how bank competition works when one bank has private information about a firm. If a bank learns private information about a firm through the process of lending, information asymmetries can arise in the bidding for a loan. This essay analyzes the predicted interest rates under this structure of competition. The model predicts that observed interest rates may be higher or lower at the lender with private information depending on the characteristics of the borrower pool. The second essay is an empirical essay that tests these theoretical predictions. The findings show that firms pay a higher interest rate when they switch to a new lender from an existing lender, which is consistent with the high quality of borrowers in my data. Additionally, the difference between the new lender and existing lender rate is greater for firms with greater information asymmetries, which is also consistent with the theory. The third essay (co-authored with Richard J. Rosen) focuses on the macroeconomic effect of information asymmetries through the credit channel. The credit channel includes the bank lending channel and balance sheet channel, but these have proven difficult to identify. The approach in this essay is to use borrowing under commitment as a baseline for loan demand, such that changes in spot lending (borrowing without a commitment) relative to commitment lending can be identified as changes in loan supply. The results indicate that, during periods of tight monetary policy, banks (a) reduce the maturity of their loans, which is consistent with the bank lending channel, and (b) shift short-term loan supply from small firms to large firms, which is consistent with the balance sheet channel. Together these findings help to identify how the credit channel works.