Borrowing from Friends of Friends: Indirect Social Networks and Bank Loans
Abstract
We examine how indirect connections (i.e., friends of friends), an important yet understudied feature of social networks, may affect bank loan contracts. Using a sample of bank loans issued by U.S. public firms, we find that indirect networks built on board interlocks significantly reduce loan spreads. However, bank monitoring and loan quality are negatively affected, suggesting that indirect networks may give rise to favoritism treatment by banks. A novel set of difference-in-difference tests exploiting changes in higher-order network structures provides the network foundation and lends support to a causal interpretation of our findings. Overall, our results suggest that indirect connections within social networks, specifically through board interlocks, can have significant economic impacts on bank loan contracts.