Credit Lines as Monitored Liquidity Insurance: Theory and Evidence

65 Pages Posted: 13 Jun 2012

See all articles by Filippo Ippolito

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Ander Perez-Orive

Federal Reserve Board

Multiple version iconThere are 3 versions of this paper

Date Written: June 11, 2012

Abstract

We propose and test a theory of corporate liquidity management in which credit lines provided by banks to firms are a form of monitored liquidity insurance. Bank monitoring and resulting credit line revocations help control illiquidity-seeking behavior by firms. Firms with high liquidity risk are likely to use cash rather than credit lines for liquidity management because the cost of monitored liquidity insurance increases with liquidity risk. We exploit a quasi-experiment around the downgrade of General Motors (GM) and Ford in 2005 and find that firms that experienced an exogenous increase in liquidity risk due to the GM-Ford downgrade (specifically, firms that were rated and that relied on bonds for financing in the pre-downgrade period) moved out of credit lines and into cash holdings in the aftermath of the downgrade. We also find support for the model's other novel empirical implication that firms with low hedging needs (high correlation between cash flows and investment opportunities) are more likely to use credit lines relative to cash, and are also less likely to require covenants and revocations when using credit lines.

Keywords: Liquidity management, cash holdings, liquidity risk, hedging, covenants, loan commitments, credit line revocation

JEL Classification: G21, G31, G32, E22, E5

Suggested Citation

Ippolito, Filippo and Acharya, Viral V. and Almeida, Heitor and Perez-Orive, Ander, Credit Lines as Monitored Liquidity Insurance: Theory and Evidence (June 11, 2012). Available at SSRN: https://ssrn.com/abstract=2081940 or http://dx.doi.org/10.2139/ssrn.2081940

Filippo Ippolito (Contact Author)

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(+34) 93 542 2578 (Phone)
(+34) 93 542 1746 (Fax)

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Heitor Almeida

University of Illinois at Urbana-Champaign ( email )

515 East Gregory Drive
4037 BIF
Champaign, IL 61820
United States
217-3332704 (Phone)

HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ander Perez-Orive

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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