Bank Lines of Credit in Corporate Finance: An Empirical Analysis

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I empirically examine the factors influencing whether firms use cash or bank lines of credit for corporate liquidity management. Bank lines of credit (revolving facilities) are only a viable liquid substitute for firms with high cash flows. Firms with low cash flows are less likely than those with high cash flows to be able to get a line of credit and rely heavily on cash for their corporate liquidity management. This correlation can be explained by banks that provide credit lines use financial covenants based on cash flow. I found that firms must maintain a high cash flow to comply with covenants. Banks restrict credit lines to firms that violate covenants. I use the cash-flow sensitivity of cash to measure financial constraints. This is statistically more powerful than the traditional measures of financial constraint used in the literature.

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