The Response of Corporate Financing and Investment to Changes in the Supply of Credit

55 Pages Posted: 7 Feb 2007 Last revised: 13 Dec 2011

See all articles by Michael R. Roberts

Michael R. Roberts

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER)

Michael L. Lemmon

University of Utah - Department of Finance

Date Written: August 26, 2007

Abstract

We examine how shocks to the supply of credit impact corporate financing and investment using the collapse of Drexel Burnham Lambert, Inc., the passage of the Financial Institutions Reform, Recovery, and Enforcement Act, and regulatory changes in the insurance industry as an exogenous contraction in the supply of below-investment-grade credit after 1989. A difference-in-differences empirical strategy coupled with a variety of treatment-control comparisons reveals that substitution to bank debt and alternative sources of capital (e.g., equity, cash balances, trade credit) was extremely limited. Consequently, net investment decreased almost one-for-one with the contraction in net issuing activity. Further, the impact of the credit contraction on financing and investment varied cross-sectionally as a function of geographic heterogeneity in the cost of bank capital and the credit risk of borrowers. Despite this sharp change in behavior, corporate leverage ratios remained relatively stable, a result of the contemporaneous decline in debt issuances and investment. Overall, our findings highlight how even large firms with access to public credit markets are susceptible to fluctuations in the supply of capital.

Keywords: Investment, Financing, Capital Structure, Supply of Credit, Bank Lending Channel, Market Segmenetation

JEL Classification: G31, G32, G21, G22, G24, G38

Suggested Citation

Roberts, Michael R. and Lemmon, Michael L., The Response of Corporate Financing and Investment to Changes in the Supply of Credit (August 26, 2007). HKUST Business School Research Paper No. 07-29. Available at SSRN: https://ssrn.com/abstract=961616 or http://dx.doi.org/10.2139/ssrn.961616

Michael R. Roberts (Contact Author)

The Wharton School - University of Pennsylvania; National Bureau of Economic Research (NBER) ( email )

3620 Locust Walk, #2320
Philadelphia, PA 19104-6365
United States
(215) 573-9780 (Phone)

HOME PAGE: http://finance.wharton.upenn.edu/~mrrobert/

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

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