Do Measures of Financial Constraints Measure Financial Constraints?
Harvard Business School
New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)
May 5, 2014
Financial constraints are not directly observable, so empirical research relies on indirect measures. We evaluate how well five popular measures (paying dividends, having a credit rating, and the Kaplan-Zingales, Whited-Wu, and Hadlock-Pierce indices) identify firms that are financially constrained, using three novel tests: an exogenous increase in a firm’s demand for credit; exogenous variation in the supply of bank loans; and the tendency for firms to pay out the proceeds of equity issues to their shareholders (“equity recycling”). We find that none of the five measures identifies firms that behave as if they were constrained: public firms classified as constrained have no trouble raising debt when their demand for debt increases, are unaffected by changes in the supply of bank loans, and engage in equity recycling. On the other hand, the behavior of all but the largest privately held firms and public firms with below investment-grade ratings is consistent with (but does not necessarily prove) the hypothesis that they are financially constrained.
Number of Pages in PDF File: 59
Keywords: Financial constraints
JEL Classification: G32, G31, G33working papers series
Date posted: October 11, 2013 ; Last revised: May 6, 2014
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