Tenant Quality and REIT Liquidity Management

Property values depend upon quality tenants and consistency (Smith: The RMA Journal 50-60, 2009). REIT firms are only as strong as their properties. In this research I examine how tenant quality affects REIT firm liquidity management (i.e. cash holdings and utilization of line of credit). I find that 1) tenant Altman Z-score and size are inversely related to total liquidity (cash plus unused credit line) and unused credit lines of REIT firms; 2) tenant size is inversely related to the total corporate liquidity and unused credit lines of REIT firms, but has no affect on REIT cash holdings; 3) tenant credit ratings are negatively related to total credit available and unused credit lines; 4) tenant book-to-market ratio and tenant profitability are negatively related to REIT cash holdings, but positively correlated to the total available credit lines and unused credit lines of REIT firms; 5) these effects vary across different property types. These results suggest that the analysis of tenant quality can offer insights into the firm policy and decision makings of REIT firms.     

What drives corporate liquidity? An international survey of cash holdings and lines of credit

We survey chief financial officers from 29 countries to examine whether and why firms use lines of credit versus non-operational (excess) cash for their corporate liquidity. We find that these two liquidity sources are employed to hedge against different risks. Non-operational cash guards against future cash flow shocks in bad times, while credit lines give firms the option to exploit future business opportunities available in good times. Lines of credit are the dominant source of liquidity for companies around the world, comprising about 15% of assets, while less than half of the cash held by companies is held for non-operational purposes, comprising about 2% of assets. Across countries, firms make greater use of lines of credit when external credit markets are poorly developed.     

What determines the composition of a firm's cash reserves?

We investigate what determines variation in the composition of the financial assets that constitute corporate cash reserves and how this variation relates to other key liquidity management practices. The degree to which a firm invests its cash reserves in less liquid, longer-maturity financial assets that earn a higher yield is explained by financial constraints, the ability to accurately forecast short-term liquidity needs, and the firm's likelihood of defaulting on its debt. During years when a firm's cash reserves are required to fund increases in investment or operating expenses the firm transfers funds from less liquid to more liquid financial assets. A firm's decisions relating to the composition of its cash reserves interacts with other key liquidity management practices, such as relying on credit lines for liquidity, extending trade credit or using it as a source of financing, and holding large amounts of inventories. Our findings provide insights on an important component of corporate liquidity management decisions.     

The use of bank lines of credit in corporate liquidity management: A review of empirical evidence

This paper reviews empirical evidence on the use of bank lines of credit as a source of corporate liquidity. Traditional explanation for lines of credit is that they provide insurance against liquidity shocks, in much the same as way hoarding cash does. However, recent empirical research suggests that access to lines of credit is contingent on the credit quality of the borrower as well as the financial condition of the lender. These findings suggest that lines of credit are an imperfect substitute for cash as a source of corporate liquidity.     

Coinsurance effect and bank lines of credit

The coinsurance effect hypothesis predicts that firm diversification reduces financial constraints through imperfectly correlated cash flows among segments. We empirically test the hypothesis by studying the relation between coinsurance effect and bank lines of credit. We find that coinsurance effect is associated with a higher availability of bank lines of credit, and that diversified firms hold a higher level of bank lines of credit if they have higher investment opportunities and if they are bank-dependent. We find that diversified firms hold a higher fraction of corporate liquidity in the form of bank lines of credit due to the coinsurance effect. The findings are consistent with the coinsurance effect hypothesis and contribute to the debate on the value consequence of firm diversification by disclosing a specific channel through which firm diversification affects financial constraints.     

Credit lines as monitored liquidity insurance: Theory and evidence

We propose a theory of credit lines provided by banks to firms as a form of monitored liquidity insurance. Bank monitoring and resulting revocations help control illiquidity-seeking behavior of firms insured by credit lines. The cost of credit lines is thus greater for firms with high liquidity risk, which in turn are likely to use cash instead of credit lines. We test this implication for corporate liquidity management by identifying exogenous shocks to liquidity risk of firms in corporate bond and equity markets. Firms experiencing increases in liquidity risk move out of credit lines and into cash holdings.     

信用卡、风险应对与城镇家庭股市参与

信用卡市场的发展有利于家庭平滑消费,但是否会影响家庭的投资决策尚缺少事实检验。基于中国家庭金融调查(CHFS)2011和2013年的调查数据,本文首次检验了信用卡对城镇家庭股市投资的影响。研究发现:(1)控制家庭财富、融资渠道、社会资本等特征,持有信用卡在边际上促进了家庭的股市参与率,股市投资额取决于信用额度。(2)中国信用卡市场的发展,并未像流动性约束理论预测的可以平滑消费,反而刺激了家庭风险性资产的配置,最终提高了储蓄率。原因在于,中国家庭更多地将信用卡作为应对未来短期突发性风险的金融工具,从而在当期将更多资产配置在风险资产上,以实现资本积累。使用信用卡数目、信用额度等多种衡量方式,并采用工具变量法(IV)和面板数据固定效应模型等解决内生性问题后,该结论稳健。该研究有助于理解信用卡在中国家庭投资决策的作用,并为流动性约束或有限股市参与假说提供中国经验。     

Information Asymmetry and Corporate Liquidity Management: Evidence from Real Estate Investment Trusts

We examine the impact of information asymmetry on a firm??s choice between cash and credit lines for corporate liquidity management using a panel data set from real estate investment trusts (REITs). Information asymmetry, as measured by analyst forecast error and dispersion, is negatively related to the use of lines of credit. Specifically, firms with more severe information asymmetry are less likely to have access to bank credit lines. Concurrently, more transparent firms are more likely to utilize bank credit lines as opposed to cash for liquidity management. The results are robust to alternative information asymmetry proxies and specifications. These findings suggest that information asymmetry plays an important role in corporate liquidity management.     

Financial constraints on investment in an emerging market crisis

We investigate whether capital market imperfections constrain investment during an emerging market financial crisis. Both large currency devaluations and banking sector failures characterize recent crises. Although a currency devaluation should increase exporters’ competitiveness and investment, a failing banking system may limit credit to these firms. Foreign-owned firms, which may have greater access to overseas financing but otherwise face the same investment prospects, provide an ideal control group for determining the effect of liquidity constraints. We test for liquidity constraints in Indonesia following the 1997 East Asian financial crisis, a period when the issuance of new domestic credit shrank rapidly. Exporters’ value added and employment increased after the crisis, suggesting that they profited from the devaluation and had sufficient cash flow to finance more workers. However, only exporters with foreign ownership increased their capital significantly. Our results suggest that liquidity constraints greatly retarded domestic-owned manufacturing firms’ ability to take advantage of improved terms of trade. Specifically, compared to foreign-owned exporters they had resembled before the crisis, after the crisis domestic-owned exporters had more than 20% lower employment and capital and more than 40% lower value added and materials usage.     

Real asset liquidity,cash holdings,and the cost of corporate debt

We study the impact of the interplay between cash holdings and asset sales on the corporate debt spread. We allow cash holdings and asset sales to assist with both debt repayment and sequential investments. The interplay between cash holdings and asset sales leads to a convex relationship between credit spreads and the liquidity of the market for real assets. We use the 2008 financial crisis as a natural experiment and find that post-2008, the nonlinearity of the link between credit spreads and asset liquidity is pronounced, closely matching analytical predictions. This is especially acute for highly leveraged and low profitability firms.     

Aggregate Risk and the Choice between Cash and Lines of Credit

Banks can create liquidity for firms by pooling their idiosyncratic risks. As a result, bank lines of credit to firms with greater aggregate risk should be costlier and such firms opt for cash in spite of the incurred liquidity premium. We find empirical support for this novel theoretical insight. Firms with higher beta have a higher ratio of cash to credit lines and face greater costs on their lines. In times of heightened aggregate volatility, banks exposed to undrawn credit lines become riskier; bank credit lines feature fewer initiations, higher spreads, and shorter maturity; and, firms’ cash reserves rise.     

Bank lines of credit as contingent liquidity: Covenant violations and their implications

We examine the relation between banks’ liquidity risk and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the asset-backed commercial paper (ABCP) market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to ABCP conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Specifically, we find that borrowers faced higher spreads over the prime rate and LIBOR as well as higher commitment fees on undrawn amounts. Our paper suggests that an increase in lender liquidity risk can bear financial implications for firms that use credit lines as an instrument of liquidity management.     

A theory of operational cash holding,endogenous financial constraints,and credit rationing

This paper develops a theory of operational cash holding. Liquidity shocks due to delayed payments must be financed using cash or short-term debt. Debt holders provide an irrevocable credit line given a firm's expected insolvency risk, and equity holders select optimum cash holding. The model demonstrates the trade-off between cash holding and investing in fixed assets. Introducing uncertain cash flows leads to precautionary cash holding if debt holders impose financial constraints. Precautionary cash holding, in turn, reduces insolvency risk enhancing access to short-term finance. The theory shows that credit rationing can occur in the absence of market frictions. Using U.S. data from 1998 to 2012, empirical findings suggest that the decline in credit lines has contributed to the increase in cash holding in line with theoretical predictions.     

Liquidity mergers

We study the interplay between corporate liquidity and asset reallocation. Our model shows that financially distressed firms are acquired by liquid firms in their industries even in the absence of operational synergies. We call these transactions “liquidity mergers,” since their purpose is to reallocate liquidity to firms that are otherwise inefficiently terminated. We show that liquidity mergers are more likely to occur when industry-level asset-specificity is high and firm-level asset-specificity is low. We analyze firms' liquidity policies as a function of real asset reallocation, examining the trade-offs between cash and credit lines. We verify the model's prediction that liquidity mergers are more likely to occur in industries in which assets are industry-specific, but transferable across firms. We also show that firms are more likely to use credit lines (relative to cash) in industries in which liquidity mergers are more frequent.     

Downstream Value of Upstream Finance

We examine market value implications of managing liquidity via supplier financing. Results suggest a direct link between shareholder wealth and use of trade credit, and the relation exhibits significant cross‐sectional variation. In particular, the market value of trade credit varies with the liquidity of goods sold and competition in product markets. Evidence also indicates the value‐supplier financing association strengthens with financial constraint, which supports the financing motive for trade credit. Further findings are consistent with the transaction cost motive. Overall, we conclude that shareholders value the strategic benefits associated with supplier financing and that downstream firms’ characteristics influence this value.     

Labor Unions and Forms of Corporate Liquidity

We examine how the presence of labor unions affects a firm's choice of corporate liquidity between bank lines of credit and corporate cash holdings. We find that firms in industries with higher unionization rates hold a higher fraction of corporate liquidity in the form of bank lines of credit. We divide the firms into sub‐groups and find that this positive relationship holds for firms that are not in a state with right‐to‐work legislation and for firms that are financially constrained. Our findings are consistent with the hypothesis that a firm chooses the forms of corporate liquidity to take advantage of the bargaining benefits associated with bank lines of credit.     

Reprint of: Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality

We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.     

Market liquidity in the financial crisis: The role of liquidity commonality and flight-to-quality

We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.     

TOWARD A MORE COMPLETE MODEL OF OPTIMAL CAPITAL STRUCTURE

Most corporate finance practitioners understand the trade-off involved in making effective use of debt capacity while safeguarding the firm's ability to execute its business strategy without disruption. But quantifying that trade-off to arrive at an optimal level of debt can be a complicated and challenging task. This paper develops a simulation model of capital structure that starts by generating multiple estimates of market rates (LIBOR, currency rates) and corresponding company operating cash flows. To arrive at an optimal capital structure, the model then incorporates the shareholder value effects of alternative financing decisions by directly measuring the costs of financial distress, including the costs of missed investment opportunities and higher working capital requirements.
The model generates both a target credit rating and a lower fallback rating that permits a higher level of debt to maintain investments and dividends when operating cash flows are weak. As the model shows, companies with volatile cash flows and significant investment opportunities can add substantial shareholder value by establishing a fallback credit rating that is one or two notches below the target rating. The model also optimizes the mix of fixed versus floating debt, the maturity structure, and the currency composition. Another distinctive feature of the model is its ability to estimate the expected cost of alternative liability structures that can provide the liquidity insurance necessary to sustain the firm through periods of severe stress. This cost turns out to be quite small relative to the total market capitalization of the average firm.     

THE EFFECTS OF BANK CONSOLIDATION ON RISK CAPITAL ALLOCATION AND MARKET LIQUIDITY

We investigate the effects of financial market consolidation on the allocation of risk capital in a financial institution and the implications for market liquidity in dealership markets. An increase in financial market consolidation can increase liquidity in foreign exchange and government securities markets. We assume that financial institutions use risk‐management tools in the allocation of risk capital and that capital is determined at the firm level and allocated among separate business lines or divisions. The ability of market makers to supply liquidity is influenced by their risk‐bearing capacity, which is directly related to the amount of risk capital allocated to this activity.