The Role of External Capital in Funding Cash Flow Shocks: Evidence From the COVID-19 Pandemic

Abstract

Using a novel measure of firms’ expected revenue shortfall at the onset of the pandemic, we study the cross sectional differences in how firms fund cash flow shortfalls. We document a U-shaped pattern, where external capital flows to firms with the largest positive and negative expected cash flow shocks. Firms traditionally considered “financially constrained” raise more - not less - capital (relative to assets), on the margin by issuing equity, while unconstrained firms rely on debt markets. Our findings suggest that external equity plays a crucial role as a financing source for smaller, younger, and otherwise riskier firms in times of stress.

Keywords: COVID-19, external financing, financial constraints, capital raising, corporate debt, zombies

JEL Classification: G01, G32