The Role of Relative Availability of Bond and Bank Financing: A Measure of Debt Inflexibility

Abstract

We study how the relative availability of bond and bank financing supply affects the firm’s ability to borrow and to use its leverage to buffer shocks. We define a measure that proxies for the regional borrowing inflexibility in the availability of bank and bond financing: “debt inflexibility”. Debt inflexibility tilts the financial structure towards equity, increasing SEOs, reducing debt issuances and lowering leverage. It proxies for a particular type of financial constraint that is more related to the local capital market to which the firm belongs, than to the characteristics of the firm itself. Debt inflexibility increases the sensitivity of cash holdings and investment to cash flows, reduces dividend payment andmakes the firm more likely to pay equity in mergers and acquisitions.

Keywords: debt inflexibility, capital structure, external financing, cash flow sensitivity, dividend payout

JEL Classification: G12, G3, G32