47 Pages Posted: 16 May 2005
Date Written: June 2006
I empirically examine the factors that determine whether firms use bank lines of credit or cash in corporate liquidity management. Bank lines of credit, also known as revolving credit facilities, are a viable liquidity substitute only for firms that maintain high cash flow. Firms with low cash flow are less likely to obtain a line of credit, and rely more heavily on cash in their corporate liquidity management. An important channel for this correlation is the use of cash flow-based financial covenants by banks that supply credit lines. Firms must maintain high cash flow to remain compliant with covenants, and banks restrict firm access to credit facilities in response to covenant violations. Using the cash flow sensitivity of cash as a measure of financial constraints, I provide evidence that lack of access to a line of credit is a more statistically powerful measure of financial constraints than traditional measures used in the literature.
Keywords: Bank Debt, Lines of Credit, Revolving Credit Facilities, Flexibility, Leverage, Corporate Liquidity, Cash-flow sensitivity of cash, Financial covenants, Covenant violations
JEL Classification: G20, G21, G32, G31
Suggested Citation: Suggested Citation
By G. Lockhart