A New Theory Of Credit Lines (With Evidence)
Professor Giorgia Piacentino
Associate Professor of Finance and Business Economics
USC Marshall School of Business
University of Southern California
We develop a dynamic model in which (latent) credit lines serve as a commitment device not to take on more debt, thereby curbing dilution incentives. Posting bundles that include credit lines allows lenders to compete more aggressively and borrowers to extract the maximum surplus. The model explains a number of empirical patterns, such as that the bulk of credit lines are not utilized and that they are bundled with loans. It also generates new predictions, notably that decreasing lender commitment increases borrower leverage and risk. We validate this prediction empirically via two natural experiments.
