The Evolution of Corporate Borrowers: Prime Versus Libor

Abstract

We extend Diamond's (1989, 1991) framework to posit that once they reach the stage of bank borrowing, firms begin with prime loans and evolve toward borrowing more cheaply at LIBOR as they grow larger, less risky and less characterized by asymmetric information. To test our extended life-cycle hypothesis, we conduct multinomial logit regressions to explain firms' membership in one of three groups: prime only, prime and LIBOR, and LIBOR. We also examine spreads over prime and LIBOR and find that loans set up to allow borrowing at prime carry higher spreads than those allowing borrowing at LIBOR as predicted by the life-cycle hypothesis.

Keywords: Corporate loans, prime, LIBOR

JEL Classification: G2, G32