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Financially Constrained Stock Returns

Author

Listed:
  • DMITRY LIVDAN
  • HORACIO SAPRIZA
  • LU ZHANG

Abstract

We study the effect of financial constraints on risk and expected returns by extending the investment‐based asset pricing framework to incorporate retained earnings, debt, costly equity, and collateral constraints on debt capacity. Quantitative results show that more financially constrained firms are riskier and earn higher expected stock returns than less financially constrained firms. Intuitively, by preventing firms from financing all desired investments, collateral constraints restrict the flexibility of firms in smoothing dividend streams in the face of aggregate shocks. The inflexibility mechanism also gives rise to a convex relation between market leverage and expected stock returns.

Suggested Citation

  • Dmitry Livdan & Horacio Sapriza & Lu Zhang, 2009. "Financially Constrained Stock Returns," Journal of Finance, American Finance Association, vol. 64(4), pages 1827-1862, August.
    • Handle: RePEc:bla:jfinan:v:64:y:2009:i:4:p:1827-1862
    DOI: 10.1111/j.1540-6261.2009.01481.x
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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