Abstract
The information content of bank loans and lines of credit
This thesis analyzes firms' abilities to communicate their private information through bank loans and lines of credit in an economy characterized by ex ante information asymmetry. Assuming that firms must externally finance an investment opportunity of different qualities, they can approach banks, other institutional lenders, or the equity market to obtain financing.
It is demonstrated that, when firms privately know the value of both their existing assets and investment opportunities, the disclosure of only a term loan does not enable the market to infer the bank's assessment of a firm value. However, when the firm also acquires a line of credit, the market can infer such information. Since firms do not have to draw down their line of credit to communicate their private information to the market, they generally prefer to approach the bank to obtain financing. Consequently, bank financing can eliminate the costs generally associated with signalling. Furthermore, the results provide a rationale for lines of credit in a risk neutral economy.
This thesis also contributes to the literature on capital structure. It is demonstrated that a unique cross-sectional capital structure exists under certain conditions. It is shown that firms endowed with a high quality project prefer debt over equity, unless the market over-values their existing assets. Conversely, firms endowed with a low quality project prefer equity over debt, unless the market under-values their existing assets.