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Financial Constraints and the Micro Origins of Aggregate Equity Shocks in Capital Markets

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  • Tobias König

Abstract

I examine how financial constraints shape the transmission of aggregate external equity financing shocks to firms' equity issuance, outstanding debt, and investment. I construct a novel instrument for aggregate equity financing shocks from firm-level data using the Granular Instrumental Variable (GIV) strategy. I find that financially unconstrained firms--characterized by high cash holdings and dividend-paying status--increase equity issuance by 1.8–2.0 percentage points, substitute equity for debt, and boost investment when capital market conditions improve. Highly leveraged firms, in contrast, refuse both to issue new equity and to reduce outstanding debt, consistent with the leverage ratchet effect. The debt overhang of highly leveraged firms results in 1.9 percentage points lower investment rates compared to the average firm. These results emphasize the crucial role of financial constraints in external equity financing and highlight the broader macroeconomic implications of debt overhang.

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  • Tobias König, 2025. "Financial Constraints and the Micro Origins of Aggregate Equity Shocks in Capital Markets," CRC TR 224 Discussion Paper Series crctr224_2025_675, University of Bonn and University of Mannheim, Germany.
    • Handle: RePEc:bon:boncrc:crctr224_2025_675
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    File URL: https://www.crctr224.de/research/discussion-papers/archive/dp675
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    More about this item

    Keywords

    Capital Markets; External Equity Financing; Granular Instrumental Variable; Financial Constraints;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • 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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