Bank Commitment Relationships, Cash Flow Constraints, and Liquidity Management

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Staff Reports

Bank Commitment Relationships, Cash Flow Constraints, and Liquidity Management

September 2000 Number 108

JEL classification: G21, G32

Author: Donald P. Morgan

Evidence in this paper suggests that a close banking relationship—a loan commitment in particular—relaxes cash flow and cash management constraints on firms. Given firms' prospects (Q), the investment and cash flow correlation is substantially lower when firms have a bank loan commitment. The difference in cash flow sensitivity reflects differences in firms' cash management practices in the face of cash flow shocks. Firms with a commitment simply run down their stocks of cash (or borrow more) when their cash flow falls but their investment prospects remain strong. The different investment-cash flow sensitivities and cash management practices suggest that the firms with a bank commitment relationship are less financially constrained.

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