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Credit Lines as Monitored Liquidity Insurance: Theory and Evidence

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  • Viral V. Acharya
  • Heitor Almeida
  • Filippo Ippolito
  • Ander Perez

Abstract

We propose and test a theory of corporate liquidity management in which credit lines provided by banks to firms are a form of monitored liquidity insurance. Bank monitoring and resulting credit line revocations help control illiquidity-seeking behavior by firms. Firms with high liquidity risk are likely to use cash rather than credit lines for liquidity management because the cost of monitored liquidity insurance increases with liquidity risk. We exploit a quasi-experiment around the downgrade of General Motors (GM) and Ford in 2005 and find that firms that experienced an exogenous increase in liquidity risk (specifically, firms that relied on bonds for financing in the pre-downgrade period) moved out of credit lines and into cash holdings in the aftermath of the downgrade. We observe a similar effect for firms whose ability to raise equity financing is compromised by pricing pressure caused by mutual fund redemptions. Finally, we find support for the model's other novel empirical implication that firms with low hedging needs (high correlation between cash flows and investment opportunities) are more likely to use credit lines relative to cash, and are also less likely to face covenants and revocations when using credit lines.

Suggested Citation

  • Viral V. Acharya & Heitor Almeida & Filippo Ippolito & Ander Perez, 2013. "Credit Lines as Monitored Liquidity Insurance: Theory and Evidence," NBER Working Papers 18892, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:18892
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    Cited by:

    1. Berrospide, Jose M. & Meisenzahl, Ralf R., 2015. "The Real Effects of Credit Line Drawdowns," Finance and Economics Discussion Series 2015-7, Board of Governors of the Federal Reserve System (U.S.).
    2. Ippolito, Filippo & Peydró, José-Luis & Polo, Andrea & Sette, Enrico, 2016. "Double bank runs and liquidity risk management," Journal of Financial Economics, Elsevier, vol. 122(1), pages 135-154.
    3. Martin, Xiumin & Roychowdhury, Sugata, 2015. "Do financial market developments influence accounting practices? Credit default swaps and borrowers׳ reporting conservatism," Journal of Accounting and Economics, Elsevier, vol. 59(1), pages 80-104.
    4. Andrea Attar & Catherine Casamatta & Arnold Chassagnon & Jean Paul Décamps, 2013. "Multiple Lenders, Strategic Default and Covenants," CEIS Research Paper 261, Tor Vergata University, CEIS, revised 08 Aug 2014.
    5. Ruprecht, Benedikt & Entrop, Oliver & Kick, Thomas & Wilkens, Marco, 2013. "Market timing, maturity mismatch, and risk management: Evidence from the banking industry," Discussion Papers 56/2013, Deutsche Bundesbank.
    6. Giuseppe Cappelletti & Paolo Emilio Mistrulli, 2017. "Multiple lending, credit lines, and financial contagion," Temi di discussione (Economic working papers) 1123, Bank of Italy, Economic Research and International Relations Area.
    7. Jie Chen & Woon Sau Leung & Wei Song & Davide Avino, 2018. "Does CDS trading affect risk-taking incentives in managerial compensation?," Working Papers 2018-19, Swansea University, School of Management.
    8. Tatyana Marchuk & Christian Schlag & Mariano Croce, 2017. "The Leading Premium," 2017 Meeting Papers 1251, Society for Economic Dynamics.
    9. Subrahmanyam, Marti G. & Tang, Dragon Yongjun & Wang, Sarah Qian, 2014. "Credit default swaps and corporate cash holdings," CFS Working Paper Series 462, Center for Financial Studies (CFS).
    10. Berlin, Mitchell & Nini, Gregory P. & Yu, Edison, 2017. "Concentration of Control Rights in Leveraged Loan Syndicates," Working Papers 17-22, Federal Reserve Bank of Philadelphia.
    11. Heitor Almeida & Murillo Campello & Igor Cunha & Michael S. Weisbach, 2014. "Corporate Liquidity Management: A Conceptual Framework and Survey," Annual Review of Financial Economics, Annual Reviews, vol. 6(1), pages 135-162, December.
    12. Shenoy, Jaideep & Williams, Ryan, 2017. "Trade credit and the joint effects of supplier and customer financial characteristics," Journal of Financial Intermediation, Elsevier, vol. 29(C), pages 68-80.
    13. Acharya, Viral & Almeida, Heitor & Ippolito, Filippo & Perez, Ander, 2014. "Bank lines of credit as contingent liquidity: A study of covenant violations and their implications," Working Paper Series 1702, European Central Bank.
    14. Acharya, Viral V & Eisert, Tim & Eufinger, Christian & Hirsch, Christian, 2014. "Real Effects of the Sovereign Debt Crisis in Europe: Evidence from Syndicated Loans," CEPR Discussion Papers 10108, C.E.P.R. Discussion Papers.
    15. repec:eee:intfin:v:50:y:2017:i:c:p:219-234 is not listed on IDEAS
    16. Cappelletti, Giuseppe & Mistrulli, Paolo Emilio, 2017. "Multiple lending, credit lines and financial contagion," Working Paper Series 2089, European Central Bank.

    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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