Credit Risk Spillovers and Cash Holdings
64 Pages Posted: 19 Mar 2018 Last revised: 25 Apr 2021
Date Written: March 15, 2018
This paper examines how credit risk spillovers affect corporate financial flexibility. We construct separate empirical proxies to disentangle the two channels of credit risk spillovers—credit risk contagion (CRC), where one firm's default increases the distress likelihood of another; and product market rivalry (PMR), where the same default strengthens the position of a competitor. We show that firms facing greater CRC have weaker subsequent operating performance and must contend with less favorable bank loan terms. Meanwhile, they accumulate more cash by issuing equity, selling assets, and reducing investment and payout. In contrast, PMR generally has opposite, albeit weaker, effects. Our findings suggest that credit risk spillovers, especially CRC, play an important role in corporate liquidity management.
Keywords: credit risk contagion; product market rivalry; financial distress; cash holdings; payout ratio; bank loan contracting
JEL Classification: G21; G32; G33
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