Credit Relationships and Dynamic Credit Constraints.
This paper presents microeconomic evidence from the U.S. syndicated loan market showing that as a credit relationship between a lender and a borrower strengthens, borrowing is more likely to be based on a firm's earnings rather than physical assets as collateral. I rationalize this in a model with limited commitment and information asymmetry, in which heterogeneity in relationship status leads to heterogeneous borrowing constraints. In a credit relationship, access to earnings-based credit increases over time because of a learning mechanism. The lender learns about the borrower's private information through repeated interactions and so updates their beliefs. This leads to a dynamic borrowing constraint for the firm, with a switch from collateral-based to earnings-based constraints as the relationship develops. Empirically, I find that the use of loan covenant, which increases credit supply by more than collateral use, increases as the lender-borrower relationship matures. Moreover, covenants tend to replace collateral requirements in a relationship. This provides direct evidence of a dynamic credit constraint in relationship lending, and demonstrates a new channel through which relationships increase credit supply by expanding access to earnings-based contracts. Finally, the effect of relationships on access to earnings-based credits is larger for smaller, typically more informationally opaque firms, underscoring the importance of the learning mechanism I Link to paper.