The effect of relationships with government owned banks on cash flow constraints: evidence from India

Description

We examine the effect of maintaining exclusive relationships with government-owned banks (GOBs) on real investment by publicly traded companies in India. Firms that maintain such exclusive relationships exhibit investment–cash flow sensitivity that is nearly 30 percent lower than that of other firms. GOB relationships also increase the sensitivity of investment to Tobin’s Q. In contrast, exclusive relationships with private banks increase cash flow sensitivity, while relationships with foreign banks have no significant impact. The lower investment–cash flow sensitivity observed among firms with exclusive GOB relationships is not driven by the selection of less financially constrained firms by GOBs. Instead, these firms tend to be in weaker financial condition relative to others—suggesting that GOBs may be engaging in the reverse of cherry-picking. Interestingly, the findings indicate that the results are driven predominantly by large firms, which benefit from exclusive GOB relationships, rather than smaller firms that are the intended beneficiaries of government-directed credit programs.

Publication Date

1-1-2016

Keywords

Banking, Government owned banks, Credit, Cash flow, Investment, India

Conference

School of Business, Economics and Law, 17th March, 2016, University of Gothenburg

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