RELATIONSHIP LENDING AND LINES OF CREDIT IN SMALL FIRM FINANCE

This article examines the role of relationship lending in small firm finance. It examines price and nonprice terms of bank lines of credit (L/Cs) extended to small firms. The focus on L/Cs allows the examination of a type of loan contract in which the bank-borrower relationship is likely to be an important mechanism for solving the asymmetric information problems associated with financing small enterprises. We find that borrowers with longer banking relationships pay lower interest rates and are less likely to pledge collateral. These results are consistent with theoretical arguments that relationship lending generates valuable information about borrower quality.