The Role of Hedge Funds as Primary Lenders

We examine the role of hedge funds as primary lenders to corporate firms. We investigate both the reasons and the implications of hedge funds’ activities in the primary loan market. We examine the characteristics of firms that borrow from hedge funds and find that borrowers are primarily firms with lower profitability, lesser credit quality, and higher asymmetric information. Our results suggest that hedge funds serve as lenders of last resort to such firms that may find it difficult to borrow from banks or issue public debt. We also examine the effect of hedge fund lending on the borrowing firms and find that borrowers’ profitability and creditworthiness improve subsequent to the loan. This beneficial effect of hedge fund lending is corroborated by our finding of positive abnormal returns for borrowers’ stocks around the loan announcement date. Overall, our findings are consistent with hedge funds adding value through their lending relationships and financial markets perceiving these activities as good news for the firms. ___________________________________________ Vikas Agarwal is from Georgia State University, Robinson College of Business, 35, Broad Street, Suite 1221, Atlanta GA 30303, USA: e-mail: [email protected] Tel: +1-404-413-7326, Fax: +1-404-413-7312. Vikas Agarwal is also a Research Fellow at the Centre for Financial Research (CFR), University of Cologne. Costanza Meneghetti is from West Virginia University, 1601 University Ave., Room 214, Morgantown, WV 26506-6025, USA: e-mail: [email protected] Tel: +1-304-293-7889, Fax: +1-304-293-5652. We are grateful to Rajesh Aggarwal, Gerald Gay, Wei Jiang, Jayant Kale, and Ilya Strebulaev for their comments. We are grateful for financial support from the BNP Paribas Hedge Fund Centre at HEC Paris. Meneghetti also acknowledges the financial support from the WVU Senate Summer Grant and the WVU College Research and Library Committee Grant. We are thankful to Linlin Ma for excellent research assistance. We are responsible for all errors.