Do Measures of Financial Constraints Measure Financial Constraints?

56 Pages Posted: 18 Oct 2013 Last revised: 30 Oct 2013

See all articles by Joan Farre-Mensa

Joan Farre-Mensa

University of Illinois at Chicago - Department of Finance

Alexander Ljungqvist

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2013

Abstract

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. The point estimates are little different for supposedly constrained and unconstrained firms, even though we find important differences in their characteristics and sources of financing. On the other hand, privately held firms (particularly small ones) and public firms with below investment-grade ratings appear to be financially constrained.

Suggested Citation

Farre-Mensa, Joan and Ljungqvist, Alexander, Do Measures of Financial Constraints Measure Financial Constraints? (October 2013). NBER Working Paper No. w19551. Available at SSRN: https://ssrn.com/abstract=2342048

Joan Farre-Mensa (Contact Author)

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Alexander Ljungqvist

Stockholm School of Economics ( email )

111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

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