How and why do small firms manage interest rate risk? Evidence from commercial loans

Although small firms are most sensitive to interest rate and other shocks, empirical work on corporate risk management has focused instead on large public companies. This paper studies fixed-rate and adjustable-rate loans to see how small firms manage their exposure to interest rate risk. The cross-sectional findings are as follows: credit-constrained firms consistently favor fixed-rate loans, minimizing their exposure to rising interest rates; firms adjust their exposure depending on how interest rate shocks covary with industry output; and "fixed versus adjustable" outcomes are correlated with lender characteristics. In a twenty-eight-year time series, the aggregate share of fixed-rate bank loans moves with interest rates in a manner consistent with recent evidence on debt market timing. I conclude that the "fixed versus adjustable" dimension of financial contracting helps small U.S. firms ameliorate interest rate risk, and discuss the implications for risk management theories and the credit channel of monetary policy.