Three essays on private information in financial intermediaries

The first essay examines the role private information plays in lending decisions. Specifically, financial intermediaries such as commercial banks make lending decisions based on the private information they gather on a borrower. Some of this information is not easily communicated or transferred and is often referred to as soft information. A lender's ability to gather and/or use soft information on a borrower can influence the type of borrowers receiving loans. The first essay in my dissertation documents the tendency for local lenders to issue loans to a particular set of borrowers (innovative firms) as the competitive landscape in the commercial banking market is changing.;In the second essay, we examine the changes in firm innovation output that arise because of the changing lending environment. We show that as a result of better access to capital, innovative output increases for firms that likely benefit from a financial intermediary's ability to use private (soft) information. However, large public firms that are less reliant on financial intermediaries like commercial banks for capital appear to decrease their innovative output. We show that the likely mechanism behind the decrease for large public firms is the inability to acquire innovative targets. Because small, private targets are the likely benefactors of better access to certain financial intermediary's (commercial banking) capital, these firms are less inclined to accept acquisition offers and the economy will forego the synergistic innovations from the merger.;The third essay examines the use of private information in the setting of market making. Financial intermediaries (market makers) at the New York Stock Exchange (NYSE) possess private information allowing them to optimize their order placement. Driven by the languishing profitability of NYSE market makers, the NYSE implemented multiple structural changes during October 2008. Market makers exchanged their private information advantage for the ability to trade at parity with external orders in the limit order book. The result of these two changes increased effective spreads by 28 basis points yielding an annual increase in transaction costs for NYSE securities of approximately...