Total Liquidity Management and Credit Line Access
66 Pages Posted: 25 Feb 2021 Last revised: 9 Dec 2022
Date Written: November 30, 2022
We add stochastic sales revenues to the business operations and model companies' total liquidity management, assuming that companies are exposed to shocks of revenues below expectations. We offer an explanation that separates all companies into three liquidity groups. Companies in group one share the highest internal liquidity, a sum of net income and cash holdings. Companies in group one do not have external debt due to their choices in an economy of uncertainty and overcapacity. Companies in group two report middle internal liquidity; they need the help of external debt, and banks admit their requests. Companies in group three have the lowest internal liquidity; they desperately need external financing, but banks reject their applications. We model banks' active roles between admissions and rejections. Banks reject an application due to concerns about the risk of not making interest rate payments or principal repayment, and bank decisions are specific to firms. Decisions of companies and banks are based on recent historical information to cope with uncertainty about revenues. Companies choose credit lines over term loans because the former address the immediate liquidity need when unexpected yet recurring income shocks hit the company. Our empirical analysis confirms the distribution of total liquidity across all companies and contracts realization for companies with access to credit lines. We further analyze the drawdown of credit lines in the 2008 crisis. Information surveyed from 10-K confirms an independent demand side story. Our study offers a unifying explanation of the interplay between internal and external liquidity.
Keywords: Total liquidity management, stochastic revenues, cash reserves, demand side shock
JEL Classification: G21, G30
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