Strategic Credit Line Usage and Performance

This paper uses a unique dataset of corporate credit line usage to examine whether firms draw precautionary balances from their credit lines in anticipation of a decline in future availability. We find that credit line drawdowns precede declines in cash flow. Further, we model predicted drawdowns and estimate unexpected drawdowns as the residual from the predictive regression. We show that unexpected drawdowns predict future cash flow declines, future covenant violations and concurrent ratings downgrades. Consistent with the use of unexpected drawdowns as a proxy for precautionary balances that are not needed for immediate investment, unexpected drawdowns are associated with increases in cash balances. Firms with unexpected drawdowns do not get better terms in renegotiations, but they are more able to finance future capital expenditures following a covenant violation than those firms without unexpected drawdowns. Overall, these findings support the hypothesis that firms strategically draw on their credit lines to access cash before their performance deteriorates.