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  3. American Economic Review
  4. July 2017
  5. Investment Banks as Corporate Monitors in the Early Twentieth Century United States

American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Investment Banks as Corporate Monitors in the Early Twentieth Century United States

  • Carola Frydman
  • Eric Hilt
American Economic Review
vol. 107, no. 7, July 2017
(pp. 1938–70)
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Abstract

We study the effect of financial relationships on firms' investment decisions and access to external finance. In the early twentieth century, securities underwriters commonly held directorships with American corporations. Section 10 of the Clayton Antitrust Act prohibited bankers from serving on the boards of railroads for which they underwrote securities. We find that following the implementation of Section 10, railroads with strong preexisting relationships with underwriters saw declines in their investment rates, valuations, and leverage, and increases in their costs of external funds. Reassuringly, we do not observe similar effects among industrials and utilities, which were not subject to Section 10. Our results are consistent with underwriters on corporate boards acting as delegated monitors, and highlight the potential for regulations intended to address conflicts of interest to disrupt valuable information flows.

Citation

Frydman, Carola, and Eric Hilt. 2017. "Investment Banks as Corporate Monitors in the Early Twentieth Century United States." American Economic Review, 107 (7): 1938–70. DOI: 10.1257/aer.20150143

Additional Materials

JEL Classification

  • G24 Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
  • G31 Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
  • G32 Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
  • G34 Mergers; Acquisitions; Restructuring; Voting; Proxy Contests; Corporate Governance
  • K22 Business and Securities Law
  • N21 Economic History: Financial Markets and Institutions: U.S.; Canada: Pre-1913
  • N22 Economic History: Financial Markets and Institutions: U.S.; Canada: 1913-