Essays on the Effect of Financial Institutions Dual Holdings of Debt and Equity Securities

This dissertation analyzes the effects on the stock markets when institutional investors hold their client firms stocks. The first essay examines the trading impact around earnings announcements and the second essay studies the effect on stock liquidity. In the first essay, we find that relationship institutions (that have lent/underwritten and hold shares of clients) support their clients when these client firms have negative earnings shocks. Their support not only mitigates the negative abnormal return around earnings announcements but also reduces the post-earnings-announcement-drift, thus, earnings momentum profits. In the second essay, we find that client firms held by relationship institutions suffer more from the adverse selection problem. As a result, they tend to have higher trading cost, more non-trading days and larger price impact of trades. These findings provide general implications for the financial institutions literature and the asset pricing literature. On the one hand, inactive institutional relationships can be considered a risk factor because supportive institutional relationships can alter stock return profiles and smooth out temporary negative shocks. On the other hand, active relationships can also create adverse selection and impose negative effects on stock liquidity.