Industry Competition and Bank Lines of Credit

Abstract

Motivated by a debate on the effect of debt on firms? product market performance, I examine the impact of lines of credit on firms? future profits. Consistent with the notion that lines of credit provide firms with unique financial flexibility and enhance their strategic position within the industry, I find supportive evidence that acquisition of lines of credit increases firms? future profit. In particular, this value-enhancing effect is more pronounced in more competitive industries. Besides, this paper also studies firms? strategic usage of lines of credit under a competitive market. Results reveal that in more competitive industries, fewer lines of credit are acquired on per firm basis, both in terms of number and dollar amount of lines of credit acquired, although aggregate industry usage is higher. Moreover, lines of credit carry less favorable contract terms when the borrowing firms are from more competitive industries, in terms of higher loan rate, lower loan amount and more stringent collateral requirement.

To ensure the robustness of the results, instrument variable analysis and natural experiments are employed to ameliorate endogeneity concerns. Overall, this study supports the view that lines of credit enhance firm value and induce firms compete more aggressively in the product market. It also highlights the role of product market competition plays in influencing the usage and contract terms of lines of credit.