Banks and Bubbles: How Good are Bankers at Spotting Winners?

Abstract

This paper examines the bank lending relationships of a large sample of technology and non-technology firms that went public during the 1996 through 2000 period. We use a unique hand collected dataset to examine the characteristics of firms that establish pre-IPO bank lending relationships and whether post-IPO performance is related to the existence and size of pre-IPO banking relationships. We find that the majority of IPO firms have banking relationships before they go public. Firms with banking relationships are older, more profitable or - in the case of tech firms have lower losses, and are more likely to have funding from venture capitalists than firms without banking relationships. We also find that banks lent aggressively to technology firms in the sense that current earnings and cash flows were significantly less important in determining banking relationships for technology firms than for non-technology firms. Consistent with the importance of so called soft information in lending decisions, we find that controlling for ex ante observable risk measures, there is a positive and significant relationship between improvements in post-IPO operating performance and the existence and size of pre-IPO banking relationships. Overall, our results indicate that firms with the best current and future prospects establish banking relationships. Our findings provide an explanation as to why investors may interpret lending relationships as a positive signal of firm quality.

JEL Classification: G30, G21, G24