Abstract:
We study the effect of relationships with financial intermediaries on firms' investment decisions and access to external finance. In the early twentieth century, securities underwriters commonly held directorships with American corporations; this was especially true for railroads, the largest enterprises of the era. Section 10 of the Clayton Antitrust Act of 1914 prohibited investment bankers from serving on the boards of railroads for which they underwrote securities, in order to eliminate the bankers' conflicts of interest. Using the volume of underwriting done by bankers on their boards to capture the extent to which railroads were affected by the regulation, we find that following the implementation of Section 10 in 1921, railroads that had maintained close affiliations with underwriters saw declines in their valuations, investment rates and leverage ratios, and increases in their costs of external funds. We perform falsification tests using data for industrials and utilities, which were not subject ​to the prohibitions of Section 10, and find no differential effect of relationships with underwriters on these firms following 1921. Our results are consistent with underwriters on corporate boards acting as delegated monitors. Our findings also highlight the potential for regulations intended to address conflicts of interest to disrupt valuable information flows.​