Reading the Fine Print
How Firm Financial Policy Affects Investment Policy
Research by Amir Sufi
Amir Sufi is assistant professor of finance at the University of Chicago Graduate School of Business.
One of the key questions in corporate finance is how a firm’s reliance on
external finance affects its investment policy. New research suggests that creditors play a much more direct role in firm investment policy than has been previously recognized.
Private credit agreements represent an ideal—and largely overlooked—setting for examining the influence of finance on investment. A private credit agreement specifies the amount, interest rate, and other terms of a loan provided by a syndicate of banks to a firm. Roughly 80 percent of all public firms maintain private credit agreements. Compared with public bonds, private credit agreements contain covenants that are more detailed, comprehensive, and tightly set, making an analysis of private contracts essential to understanding the impact of external finance on firm behavior.
In the study “Creditor Control Rights and Firm Investment Policy,” University of Chicago Graduate School of Business professor Amir Sufi and coauthors Greg Nini of the Board of Governors of the Federal Reserve System and David C. Smith of the University of Virginia’s McIntire School of Commerce present new evidence that creditors exert direct control over the investment policy of solvent public firms via credit agreements.
The authors examined 3,720 contracts between U.S. banks and 1,931 publicly traded U.S. corporations from 1996 to 2005. They found that 32 percent of these contracts contained an explicit restriction limiting the firm’s capital expenditures. Such restrictions are more likely to be added following a decline in a ...