Do Banks Provide Financial Slack?

Authors

  • Charles J. Hadlock,

  • Christopher M. James

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    • Charles Hadlock is at Michigan State University. Christopher James is at the University of Florida. An earlier version of this paper was titled “Bank Lending and the Menu of Financing Options.” We thank Andres Almazan; Ronald Anderson; David T. Brown; Jon Garfinkel; Joel Houston; Jay Ritter; René Stulz; and seminar participants at CEPR, the Federal Reserve Board of Governors, the Federal Reserve Banks of Atlanta and New York, Tulane University, the University of Florida, and Washington University (St. Louis); and especially Mark Carey for helpful comments and suggestions. Ted Fee, Wei-Lin Liu, and Jeff Jewell provided excellent research assistance. All errors remain our own.

ABSTRACT

We study the decision to choose bank debt rather than public securities in a firm's marginal financing choice. Using a sample of 500 firms over the 1980 to 1993 time period, we find that firms are relatively more likely to choose bank loans when variables that measure asymmetric information problems are elevated. The sensitivity of the likelihood of choosing bank debt to information problems is greater for firms with no public debt outstanding. These results are consistent with the hypothesis that banks help alleviate asymmetric information problems and that firms weigh these information benefits against a wide range of contracting costs when choosing bank financing.

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