Bank Debt, Flexibility, and the Use of Proceeds from Asset Sales

In the theory of financial intermediation, bank debt is often characterized as being more readily renegotiable than public debt. Banks are also conjectured to gain valuable non-public information through closer monitoring. Given these features, bank debt can theoretically be more flexible than public debt and can lead to better investment/liquidation decisions. We investigate this possibility using a sample of firms facing the important decision of whether to reinvest the proceeds from asset sales or whether to distribute the proceeds to debtholders. While higher levels of leverage are associated with an increased probability of distributing proceeds to creditors, this relationship is significantly muted for bank debt as opposed to public debt. This finding is consistent with the conjecture that bank debt provides enhanced flexibility when compared to public debt. Further we find that asset sale announcement period abnormal stock returns are increasing in firms’ use of bank debt, but not public debt. This suggests that market participants believe that banking relationships are leading to better decision making for this particular type of investment/liquidation decision. We find no significantly different effects of bank vs. public debt on the initial decision to undertake an asset sale in the first place. Thus, in the context of asset sales, the main observable difference arises in the use of proceeds decision, rather than the initial asset sale decision.