Local Debt Inflexibility and the Transmission of Credit Supply Shocks

50 Pages Posted: 17 Mar 2012

See all articles by Lei Zhang

Lei Zhang

University of Queensland - Business School

Massimo Massa

INSEAD - Finance

Date Written: March 15, 2012

Abstract

We focus on how market frictions in the ability to replace bank financing with bond financing affect the ability of the firm to buffer shocks. We first provide evidence of a strong local segmentation in the debt market. We then build a measure of local debt inflexibility that captures the difficulty to replace bank loans with bonds, and test how this affects the reaction of the firm to changes in bank credit supply. We consider two proxies on bank credit availability– i.e, the ratio of non-performing loans to total assets and the Senior Loan Officer Opinion Survey on Bank Lending Practices. We show that more inflexible firms suffer a bigger increase in bond yield spreads as bank credit supply drops. The impact is stronger among smaller firms, firms with higher investment needs, and during the sub-prime mortgage crisis period. Debt inflexibility also amplifies the firm-specific shocks to bank credit supply induced by the violation of loan covenants. More inflexible firms display a stronger link between stock volatility and cash flow volatility, as well as overall higher volatility and stock beta. We further document that debt inflexibility strongly impacts the connection between bond yield spreads and equity volatility (Campbell and Taksler, 2003), i.e., firms that are more inflexible have a higher yield spread sensitivity to the volatility of their equity.

Keywords: local bias, bank credit supply, idiosyncratic volatility, credit spreads, debt inflexibility

JEL Classification: G12, G3, G32

Suggested Citation

Zhang, Lei and Massa, Massimo, Local Debt Inflexibility and the Transmission of Credit Supply Shocks (March 15, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2023723 or http://dx.doi.org/10.2139/ssrn.2023723

Lei Zhang (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Massimo Massa

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

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