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Do Measures of Financial Constraints Measure Financial Constraints?

Author

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  • Joan Farre-Mensa
  • Alexander Ljungqvist

Abstract

Financial constraints are fundamental to empirical research in finance and economics. We propose two tests to evaluate how well measures of financial constraints actually capture constraints. We find that firms typically classified as constrained do not actually behave as if they were constrained: they have no trouble raising debt when their demand for debt increases exogenously and use the proceeds of equity issues to increase payouts to shareholders. Our evidence suggests that extant findings that have been attributed to constraints may instead reflect differences in the growth and financing policies of firms at different stages of their life cycles. Received December 9, 2014; accepted August 18, 2015 by Editor David Denis.

Suggested Citation

  • Joan Farre-Mensa & Alexander Ljungqvist, 2016. "Do Measures of Financial Constraints Measure Financial Constraints?," The Review of Financial Studies, Society for Financial Studies, vol. 29(2), pages 271-308.
    • Handle: RePEc:oup:rfinst:v:29:y:2016:i:2:p:271-308.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhv052
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    JEL classification:

    • 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
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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