Firms are financially constrained because external funds are more costly than internal funds in imperfect financial markets. If banks play a role in alleviating information costs, financial constraints faced by firms decrease with bank dependency. The study finds that investments for firms with higher bank debt ratio respond less sensitively to cash flow using the Korean firm level data. This implies that a close bank relationship improves the accessibility to external funds by firms. The effect of a bank relationship on sensitivity of investment to internal funds is pronounced for large firms and is reinforced after a financial crisis.
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