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

Published online by Cambridge University Press:  28 April 2010

Michael Lemmon  and
Michael R. Roberts
Michael Lemmon
Affiliation:
Eccles School of Business, University of Utah, 1645 E. Campus Center Dr., Rm. 109, Salt Lake City, UT 84112. [email protected]
Michael R. Roberts
Affiliation:
Wharton School, University of Pennsylvania, 3620 Locust Walk, Ste. 2300, Philadelphia, PA 19104. [email protected]
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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 of 1989; 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 reveals that substitution to bank debt and alternative sources of capital (e.g., equity, cash balances, and trade credit) was limited, leading to an almost one-for-one decline in net investment with the decline in net debt issuances. 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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 3 , June 2010 , pp. 555 - 587
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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