Staff Report, Federal Reserve Bank of New York 108
Evidence in this paper suggests that a close banking relationship -- a loan commitment in particularparticular, relax 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.