Liquidity Management and Corporate Investment During a Financial Crisis

TLDR: In this article, the authors used a unique dataset to study how firms managed liquidity during the 2008-09 financial crisis and found that companies substitute between credit lines and internal liquidity (cash and profits) when facing a severe credit shortage.

Abstract: This paper uses a unique dataset to study how firms managed liquidity during the 2008-09 financial crisis. Our analysis provides new insights on interactions between internal liquidity, external funds, and real corporate decisions, such as investment and employment. We first describe how companies used credit lines during the crisis (access, size of facilities, and drawdown activity), the characteristics of these facilities (fees, markups, maturity, and collateral), and whether managers had difficulties in renewing or initiating lines. We also describe the dynamics of credit line violations and the outcome of subsequent renegotiations. We show how companies substitute between credit lines and internal liquidity (cash and profits) when facing a severe credit shortage. Looking at real-side decisions, we find that credit lines are associated with greater spending when companies are not cash-strapped. Firms with limited access to credit lines, on the other hand, appear to choose between saving and investing during the crisis. Our evidence indicates that credit lines eased the impact of the financial crisis on corporate spending.

Figures

Figure 1 — Economic Effect of Internal Liquidity on Credit Lines This figure depicts the sensitivity of credit lines to internal liquidity. Panel A shows the percentage change in credit lines [vertical axis] associated with a one-interquartile range (IQR) change in cash flows (=0.12) at different levels of cash holdings [horizontal axis]. Panel B shows the percentage change in credit lines associated with a one-IQR change in cash holdings (=0.12) at different levels of cash flows.

Table 8 — Credit Lines Commitment Fees and Firm Characteristics This table reports logit and OLS results from commitment fee regression models. In the logit regressions, the dependent variable is equal to 1 if the firm reports a commitment fee for its outstanding credit line and zero otherwise. In the OLS regressions, the dependent variable is the commitment fee in basis points. All regressions include a constant term (not reported). The data are gathered from the 2009Q2 survey. Refer to Table 1 for detailed independent variable definitions. t-statistics reported in parentheses are based on heteroskedasticity-consistent standard errors adjusted for clustering across observations of a given industry.

Table 10 About Here

Figure 2 About Here

Table 9 — Covenant Violation, Renegotiation, and Role of Credit Lines During the Credit Crisis This table reports covenant violations and changes in the terms of credit lines in the 2008-2009 period. The data are gathered from the 2010Q2 survey. Panel A shows the percentage of credit lines that violated covenants and drawdowns as a percentage of available credit line before and after covenant violations. Panel B shows, for the subsample of firms that violated covenants, the percentage of firms that violated financial and/or operational covenants and whether, as a consequence of the violation, the credit line had to be canceled or renegotiated. Panel C shows the changes in the terms of credit lines after a violation. Panel D shows what percentage of firms are more willing to pay now (as a consequence of the credit crisis) a commitment fee to have access to a credit line accessible in case of necessity.

Table 4 — Drawdowns versus External Financing in the Crisis This table reports mean comparisons of the ratio of drawdowns to the sum of total external funds (drawdowns, equity issuances, short-term debt issuances, long-term debt issuances, and commercial paper issuances). The data are gathered from the 2009Q1 survey.

Full text

Liquidit y M anagem en t and Corporate In v estmen t
Du ring a F in a n c ia l C ris is*
Murillo Campello Erasmo Giambona
University of Illinois University of Amsterdam
&NBER
campello@illinois.edu e.giambona@uva.nl
John R. Graham Campbell R. Harvey
Duke University Duke University
&NBER &NBER
john.graham@duke.edu cam.harvey@duke.edu
This Draft: October 12, 2010
Key words: Financial crisis, liquidity management, investment spending, credit lines, drawdown
activity, cash s avings.
JEL classification: G31, G32.
*Corresponding author: Campbell R. Harvey, Fuqua School of Business, Duke University, Durham,
NC 27708-0120. E-mail: cam.harvey@duke.edu. We thank James Choi, Enrica Detragiache, Jean
Helwege, Matt Spiegel (the editor), Ilya Strebulaev, Amir Sufi, Yongjun Tang, and two anony-
mous referees for their suggestions. We also benefited from comments from seminar participants
at the ECB/CFS Conference (2009), FIRS Conference (2010), Global Issues in Accounting Confer-
ence (2010), RFS/Yale Financial Crisis Conference (2009), University of Amsterdam, University of
Bologna, and WFA Meetings (2010). We thank CFO Magazine for helping us conduct the surveys,
though we note that our analysis and conclusions do not necessarily reflect those of CFO . We thank
Benjamin Ee and Hyunseob Kim for excellent research assistance.
1

Liquidit y M anagem en t and Corporate In v estmen t
D uring a Financial C risis
Abstract
This paper uses a unique dataset to study how firms managed liquidity during the 2008-09 financial crisis.
Our analysis provides new insights on interactions between internal liquidity, external funds, and real cor-
porate decisions, such as investment and employment. We first describe how companies used credit lines
during the crisis (access, size of facilities, and drawdown activity), the characteristics of these facilities (fees,
markups, maturity, and collateral), and whether managers had difficulties in renewing or initiating lines. We
also describe the dynamics of credit line violations and the outcome of subsequent renegotiations. We show
how companies substitute bet ween credit lines and internal liquidity (cash and profits) when facing a severe
credit shortage. Looking at real-side decisions, we find that credit lines are associated with greater spending
when companies are not cash-strapped. Firms with limited access to credit lines, on the other hand, appear
to choose between saving and investing during the crisis. Our evidence indicates that credit lines eased the
impact of the financial crisis on corporate spending.
Key words: Financial crisis, liquidity management, investment spending, credit lines, drawdown
activity, cash savings.
JEL classification: G31, G32.
2

In the spring of 2009, world financial markets were in the midst of a credit crisis of historic pro-
portions. While unfortunate, the crisis en vironment created an opportunity to draw crisp inferences
about corporate behavior. In this paper, we study interactions between internal and external sources
of liquidity and show how those interactions affect comp anies’ decisions regarding capital investment,
technology spending, and employment. While prior research has looked at the impact of cash and
profits on firm behavior, we consider an additional source of liquidity: lines of credit.
Companies rely extensively on credit lines provided by banks (see Shockley and Thakor (1997)).
Contemporary papers document increased corporate use of credit lines during the financial crisis
(Ivashina and Sc harfstein (2010) and Campello et al. (2010)). Others shed light on the relation
between credit lines and cash (Lins et al. (2010)) or profitability (Sufi (2009)). In contrast, our
paper examines how firms choose between different sources of liquidity when liquidity is scarce. Our
paper is the first to study during a credit crisis the demand for credit lines, the costs associated with
credit lines, the ease with which firms are able to initiate or renew lines, the consequences of violating
a credit line covenant, the outcomes of renegotiation after violations, and how firms manage liquidity
coming (concurrent ly) from credit lines, cash holdings, and profits. Notably, our study also provides
new insigh t into the relation between liquidity management and real expenditures during the crisis.
To learn how firms manage liquidity and investment when liquidity is scarce, in early 2009 we
surveyed 800 CFOs from North America, Europe, and Asia, asking about their cash holdings, profits,
access to bank credit lines, use of available lines, the costs associated with credit lines, and their pro
forma plans regarding investment, technology, and employment expenditures.
1
In contrast to studies
of observed (ex-post) outcomes based on archival data, our survey approach allows us to examine
firms’ planned (ex-ante) policies and the relations between liquidity and real decisions. In this way, we
study decisions that are not contaminated by events that may co-determine observed corporate be-
havior but that were not part of managers’ information sets when they form ulated their policies (such
as the outcomes of governmental programs put in place to address the crisis). Our approach allows
us to establish clear, timely links between credit availability and firms’ financial and real decisions.
Detailed data on credit lines are not available from standard commercial databases. COMPU-
3

STAT, for example, does not have this information, and LPC-Dealscan only has originations (not
balances), and even then only for larger firms and banks. Archival data sources are unlikely to have
information on companies’ difficulties in renewing a line, much less on deals that did not go through.
In addition, these sources do not provide detail on loan covenant violations or line renegotiations.
Our survey instrument yields new data on all of these dimensions. These data describe the deter-
minan t s of credit lines (size of facilities), the use of available credit lines (drawdowns), the maturity
and costs of those facilities (commitment fees, interest spreads, use of collateral), the frequency and
reasons for covenant violations, the consequences of violations, the outcomes of renegotiations, and
the interactions between credit lines and other sources of internal liquidity (cash holdings and cash
flows) during the crisis. I n contrast to most papers, we gather information from both public and
private firms. Our data yield new evidence on the use and cost of external liquidity during the
financial crisis, showing how firms substitute bet ween internal and external funds in that period.
We first study how firms managed their credit lines during the crisis. Firms that are small, pri-
vate, non-investment grade, and unprofitable had significantly higher lines-to-asset ratios than their
larger, public, investment grade, profitable counterparts, both in 2008 and in 2009. Our data show
that the first set of firms drew significantly larger amounts of funds under their line facilities during
the crisis. For example, private firms drew, on average, 42% of the total funds in their lines in 2009,
compared to only 26% for public firms. Univariate tests also uncover a negative correlation between
credit lines and cash balances.
Next, we examine how companies’ cash and profitability affect the use of credit lines (size of facili-
ties and draw down activity). We do so using an interactive regression model. For a firm with little or
no cash, a one-in terquartile range (IQR) increase in cash flows is associated with an increase of 4% in
the ratio of credit lines-to-total assets (the sample average ratio is 24%). However, the positive asso-
ciation between cash flow and credit lines becomes weak as firms hold more cash. At the ninth decile
of cash holdings, for example, a one-IQR change in cash flow does not affect credit lines. Our tests
thus show that higher cash flows need not lead to increases in the size of credit lines. More generally,
they point to a substitution effect between internal and external sources of liquidity during the crisis.
4

One of the advantages of our data is that we can study line drawdown activity. Firms with higher
cash flows drew fewer funds from their credit lines, as did firms with more cash on hand. In other
words, conditional on having a line, cash flows and cash holdings both lead to smaller drawdowns.
Our drawdown results are also consistent with a substitution between internal and external liquidity
during the crisis. Notably, different from tests that are based on the size of credit lines, the draw-
down tests are not subject to a reverse-causality critique: smaller drawdowns cannot cause the firm
to have more cash in hand.
Our findings indicate that firms choose not to use credit lines when they have enough internal
funds, implying a cost wedge between these t wo sources of liquidity. It is thus important that we
understand how lines are priced during the crisis. To investigate this issue, in a subsequent survey
(conducted in the second quarter of 2009) we gather data on the pricing of credit line facilities (both
during that quarter as well as in the second quarter of 2008). While it is not surprising that credit
facilities became generally more costly, we are able to identify and characterize heterogeneity across
firms. In the U.S., commitment fees increased by 14 basis points on average (i.e., nearly doubled)
over the crisis. For small, private, non-in vestment grade, unprofitable borrowers, average markups
over LIBOR/Prime increased between 70 and 95 basis points, and the average line maturity declined
by about 3 months (down from 26 months in early 2008). Other borrowers observed less pronounced
changes in the pricing of their lines. We also find that firms with more internal liquidity w ere less
likely to pa y a commitment fee (extensive margin), and that, conditional on paying a fee, they paid
lower fees (intensive margin). In other words, firms with more internal funds could access lines of
credit at a lower cost, yet they borrowed less from those facilities.
We also gather data on violations of credit line co venan ts and on outcomes of subsequent rene-
gotiations. We show, for example, that a relatively small fraction of firms (10%) have their lines
canceled upon violating covenants in the crisis. At the same time, about two-thirds of violators are
able to renegotiate the terms of their lines. Nearly 70% of those who renegotiate report an increase in
the cost of those lines (markups and fees). Line drawdown activity is also reduced after a violation.
The last part of our analysis examines the interplay between corporate liquidity and real-side poli-
5

Frequently asked questions

Q1. What contributions have the authors mentioned in the paper "Liquidity management and corporate investment during a financial crisis*" ?

This paper uses a unique dataset to study how firms managed liquidity during the 2008-09 financial crisis. The authors first describe how companies used credit lines during the crisis ( access, size of facilities, and drawdown activity ), the characteristics of these facilities ( fees, markups, maturity, and collateral ), and whether managers had difficulties in renewing or initiating lines. The authors also describe the dynamics of credit line violations and the outcome of subsequent renegotiations. The authors show how companies substitute between credit lines and internal liquidity ( cash and profits ) when facing a severe credit shortage. 

Q2. What have the authors stated for future works in "Liquidity management and corporate investment during a financial crisis*" ?

The analysis in this section simply draws from other literatures on corporate borrowing to study how different firms are affected by the credit crisis. 10We do not find significant differences when the authors fit their new model separately for public and private firms. 12We thank an anonymous referee for this suggestion. 16Put differently, while firms may be forced to choose between saving cash and investing in the 29 absence of credit lines, the effect of cash on investment should switch from negative to positive at a relatively lower level of credit lines for firms with better investment opportunities ( since sacrificing investments for the sake of saving funds is particularly costly for these firms ). 

Q3. Why does Sufi conclude that more profitable firms use more lines of credit than cash in their?

Sufi concludes that more profitable firms use significantly more lines of credit than cash in their liquidity management because higher profits makes a firm less likely to violate covenants. 

Q4. How many respondents said they would not pay for a rainy day credit line?

About 55% said they would not be willing to pay for a rainy day credit line; nearly half of respondents (22%) said they would not pay because they already held “excess cash for the same purpose. 

Q5. What is the effect of cash and cash flows on fee reductions?

The cash flow—cash holdings interaction term is positive and highly significant in the OLS fee model, indicating that there are diminishing marginal benefits to the independent effects of cash and cash flows on fee reductions. 

Q6. What is the rationale for switching from cash savings to investment spending?

For firms with a high opportunity cost of investment (more attractive investment prospects), it will be rational to switch from cash savings to investment spending starting at lower levels of credit lines. 

Q7. Why do the authors restrict their attention to the set of public firms in their sample?

Because COMPUSTAT reports information only on public firms, the authors restrict their attention to the set of public firms in their sample for the purpose of this comparison. 

Q8. How many private firms experienced difficulty in obtaining or maintaining a line of credit?

The authors find that 23% of private firms experienced difficulty in obtaining or maintaining a line of credit, compared to 14% of public firms. 

Q9. How many respondents said they would pay a premium to arrange a rainy day facility?

More than 45% of respondents said that they would pay a small, moderate, or large premium (30.4%, 13.6%, and 1.3%, respectively) to arrange a rainy day facility. 

Q10. Why does the interaction term change at higher levels of cash holdings?

Due to the positive coefficient on the interaction term, however, this internal—external liquidity dynamic changes at higher levels of cash holdings. 

Q11. What are the main variables asked to rate their firms’ long-term investment prospects?

Managers are also asked to rate (on a 0 to 100 scale) their firms’ long-term investment prospects and also rate their firms’ access to credit. 

Q12. How many firms faced difficulties in renewing a credit line?

The authors add to this by quantifying that in the midst of a severe credit contraction four-in-five of the respondent companies do not face difficulties in renewing a credit line.