Liquidity Management and Corporate Investment During a Financial Crisis

Abstract:     
As liquidity became scarce and internal profits plunged, many firms were forced to rely on bank lines of credit during the 2008-9 financial crisis. Surprisingly, little is known about these credit facilities in general, let alone about their importance during a crisis. This paper investigates a unique dataset that describes how public and private firms in the U.S. and abroad use lines of credit during early 2009. Our analysis emphasizes the interaction between internal funds, external funds, and real decisions such as corporate investment and employment. Among other things, we find that firms that are "credit constrained" (small, private, non-investment grade, and unprofitable) have larger credit lines (as a proportion of assets) than their large, public, investment-grade, profitable counterparts both before and during the crisis. Constrained firms draw more funds from their credit lines and are more likely to face difficulties in renewing or initiating new lines during the crisis. The terms of credit line facilities changed significantly with the crisis: maturities declined; and commitment fees and interest spreads went up for all firms, but particularly for constrained firms. Our evidence suggests that while being profitable helps firms establish credit lines, it does not monotonically lead to increased use. Instead, lines of credit are used when internal funds (cash stocks and cash flows) decline. Looking at real-side decisions, our estimates suggest that lines of credit provide the liquidity "edge" firms need to invest during the crisis.

Keywords: Financial crisis, investment, liquidity management, lines of credit

JEL Classifications: G31

Working Paper Series