Liquidity, Firm Value and Long-Term Bank Relationships

Abstract:     
Our interest here concerns liquidity supply as a distinctive feature of the bank-firm relationship. Any agent facing an opportunity or a commitment may find him/herself unexpectedly illiquid, and hence he/she may find it profitable to borrow "on call" if this costs less than missing the opportunity or defaulting on the commitment, or it costs less than using non-money assets as means of payment. We first examine the relation between firm value and access to liquidity supply, and then we investigate the efficiency properties of bank refinancing contracts in a continuous time stochastic model of a repeated firm-bank relationship, where the key problem is the credibility of the mutual commitment between the two parties. Our main finding is that cost-minimizing and renegotiation-proof contracts emerge in the absence of perfect commitment and enforceability of payments as the borrower and the bank can exert mutual threat of termination.

Number of Pages in PDF File: 36

Keywords: Liquidity, firm value, bank relationships

JEL Classification: C73, G21, G33

working papers series