Ebook Liquidity Management and Corporate Investment During a Financial Crisis
In the spring of 2009, world financial markets were in the midst of a credit crisis of historic proportions. While unfortunate, the financial crisis environment created a unique opportunity to draw crisp inferences about how firms vary the use of internal and external funds, and how funding options affect real-side decisions such as capital spending.
There is a long literature on the importance of internal funds as a source of financing for corporate investment. According to this literature, profits are likely to become a crucial funding source when firms face financing constraints (Fazzari et al. (1988)) or when credit is tight in the aggregate economy (Bernanke and Gertler (1989)). In this paper, we study the interaction between different sources of corporate funding and how that interaction affects decisions such as capital investment, technology spending, and employment. We do this using data collected in the midst of the 2009 financial crisis. While previous papers focus on the impact of firms’ internal liquidity (namely, cash holdings and cash flows) on their real policy variables, we consider an additional form of liquidity: bank lines of credit.
It is well known that companies make extensive use of committed credit facilities provided by banks (see, e.g., Shockley and Thakor (1997)). Even so, little is known about the determinants of credit lines use. Theory suggests that a bank line of credit can function as an insurance policy against liquidity shortages (Thakor (1995) and Holmstrom and Tirole (1998)). Credit lines work particularly well during times when firms have limited access to the capital markets, and differently from cash, credit lines have very low carry costs.
The optionality of immediate access to liquidity that is engendered by credit lines raises a number of questions. Who uses lines of credit when capital markets collapse? How do credit lines interact with internal liquidity? Are these sources of liquidity substitutes or complements during a liquidity crisis? How are these credit facilities priced? Does line of credit access affect real-side decisions such as investment and employment? In this paper, we study these and a number of related questions. We do so by examining the role played by credit lines during the 2008-9 financial crisis, a time in which there was both an aggregate credit supply shortage and much variation in credit demand by firms.
Evidence of an aggregate supply shock was plentiful. New Commercial and Industrial (C&I) loans extended by commercial banks dropped from $54 billion in February 2007 to about $42 billion in February 2009. At the same time, loans made under commitment as a percentage of total C&I loans increased from 75% in February 2007 to 89% in February 2009 (cf. Federal Reserve’s Survey of Terms of Business Lending). Differently from prior episodes, this negative shift in the supply of credit was originated from financial institutions’ exposure to non-corporate liabilities: the generation and repackaging of housing mortgages. Given the large, exogenous contraction in the supply of external finance in 2008-9, our hypothesis is that liquid assets (e.g., cash balances and lines of credit) suddenly became more important funding sources.
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