Going public reduces information asymmetry between a firm’s incumbent and potential new lenders. However, we show that while loan spreads are lower in post-IPO loans due to increased lender competition, the likelihood of having interest-increasing performance-pricing, which automatically increases spreads if firm performance deteriorates, is substantially heightened, only for loans from new lenders. This indicates that new lenders remain skeptical despite a more “level playing field.” Newly public firms need to commit to performance-sensitive debt to convince outside lenders, despite gaining a credible mechanism to disseminate information to them. Pricing grids do get amended more often ex-post for such loans, reflecting a lender learning process. Newly public firms are indeed still more likely to obtain loans from new lenders post-IPO. Our results suggest that performance pricing can serve to address the remaining information gap with new lenders beyond hard-information disclosure, allowing firms to better diversify their lender base.

ABSTRACT This paper examines the credit supply-side effect of the U.S. 2003 dividend tax cut on the real economy through the banking sector. We show that C-corporation banks (treatment group), particularly those capital-constrained, increase the supply of small business loans more than S-subchapter banks (control group) following the tax cut, aligning with the old view of dividend taxation and the supply-side effect rooted in credit rationing. Such an enhanced small business loan supply stemming from the tax cut translates into real effects on the economy. We find that areas with a greater presence of C-corporation banks exhibit more small business formations, employment, and innovations. The positive real effects are concentrated in subsamples when business growth opportunities are more abundant or international trade exposures are higher. Overall, our findings add to the literature on the real effects of the tax cut by showing an important yet unexplored bank credit supply channel.