Hostname: page-component-586b7cd67f-g8jcs Total loading time: 0 Render date: 2024-11-21T23:44:50.307Z Has data issue: false hasContentIssue false
  • English
  • Français

Uncovering Financial Constraints

Published online by Cambridge University Press:  05 May 2023

Matthew Linn  and
Daniel Weagley
Matthew Linn*
Affiliation:
University of Massachusetts Amherst Isenberg School of Management
Daniel Weagley
Affiliation:
Georgia Institute of Technology Scheller College of Business [email protected]
*
[email protected] (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

We use a random forest model to classify firms’ financial constraints using only financial variables. Our methodology expands the range of classified firms compared to text-based measures while maintaining similar levels of informativeness. We construct two versions of our constraint measures, one using many firm characteristics and the other using a small set of more primitive characteristics. Using our measures, we find that institutional investors hold a lower percentage of shares in equity-focused constrained firms, while retail investors show a preference for them. Equity issuance and investment of constrained firms also increases during periods of high investor sentiment.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 6 , September 2024 , pp. 2582 - 2617
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Jarrad Harford (the editor) and Gerard Hoberg (the referee) for constructive comments in the review process. We are grateful to Taylor Begley, Donald Bowen, András Danis, Joan Farra-Mensa, Anisha Ghosh (discussant), Sudip Gupta (discussant), Charles Hadlock (discussant), Armen Hovakimian (discussant), Alex Hsu, Russell Jame, Nikunj Kapadia, Soohun Kim, Bradley Paye, Manpreet Singh, Jason Sockin (discussant), Huan Yang, and seminar and conference participants at Georgia Tech, University of Massachusetts, Virginia Tech, the 2018 Northern Finance Association Conference, the 2019 Dolomites Winter Finance Conference, the 2019 Financial Management Association Conference, the 2020 Midwest Finance Association Conference, and the 2022 University of Florida Research Conference on Machine Learning in Finance for helpful comments on the article. Any remaining errors are our own. Some of the ideas in this article were spun out of a previous working article entitled “Seeing the Forest Through The Trees: Do Investors Underreact to Systemic Events?” This article was briefly circulated under the title “Estimating Financial Constraints with Machine Learning.”

References

Admati, A. R., and Pfleiderer, P.. “The “Wall Street Walk” and Shareholder Activism: Exit as a Form of Voice.” Review of Financial Studies, 22 (2009), 2645–2685.CrossRefGoogle Scholar
Almeida, H., and Campello, M.. “Financial Constraints and Investment-Cash Flow Sensitivities: New Research Directions.” Twelfth Annual Utah Winter Finance Conference (2001).CrossRefGoogle Scholar
Appel, I. R.; Gormley, T. A.; and Keim, D. B.. “Passive Investors, Not Passive Owners.” Journal of Financial Economics, 121 (2016), 111–141.CrossRefGoogle Scholar
Baker, M., and Wurgler, J.. “Investor Sentiment and the Cross-Section of Stock Returns.” Journal of Finance, 61 (2006), 1645–1680.CrossRefGoogle Scholar
Barber, B. M., and Odean, T.. “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.” Journal of Finance, 55 (2000), 773–806.CrossRefGoogle Scholar
Bernanke, B. S.; Gertler, M.; and Gilchrist, S.. “The Flight to Quality and the Financial Accelerator.” Review of Economics and Statistics, 78 (1996), 1–15.CrossRefGoogle Scholar
Bodnaruk, A.; Loughran, T.; and McDonald, B.. “Using 10-K Text to Gauge Financial Constraints.” Journal of Financial and Quantitative Analysis, 50 (2015), 623–646.CrossRefGoogle Scholar
Boehmer, E., and Kelley, E. K.. “Institutional Investors and the Informational Efficiency of Prices.” Review of Financial Studies, 22 (2009), 3563–3594.CrossRefGoogle Scholar
Buehlmaier, M. M., and Whited, T. M.. “Are Financial Constraints Priced? Evidence from Textual Analysis.” Review of Financial Studies, 31 (2018), 2693–2728.CrossRefGoogle Scholar
Carleton, W. T.; Nelson, J. M.; and Weisbach, M. S.. “The Influence of Institutions on Corporate Governance through Private Negotiations: Evidence from TIAA-CREF.” Journal of Finance, 53 (1998), 1335–1362.CrossRefGoogle Scholar
Chava, S.; Danis, A.; and Hsu, A.. “The Economic Impact of Right-to-Work Laws: Evidence from Collective Bargaining Agreements and Corporate Policies.” Journal of Financial Economics, 137 (2020), 451–469.CrossRefGoogle Scholar
Farrell, M.; Green, T. C.; Jame, R.; and Markov, S.. “The Democratization of Investment Research and the Informativeness of Retail Investor Trading.” Journal of Financial Economics, 145 (2022), 616–641.CrossRefGoogle Scholar
Farre-Mensa, J., and Ljungqvist, A.. “Do Measures of Financial Constraints Measure Financial Constraints?” Review of Financial Studies, 29 (2016), 271–308.CrossRefGoogle Scholar
Fazzari, S. M.; Hubbard, R. G.; and Petersen, B. C.. “Financing Constraints and Corporate Investment.” Brookings Papers on Economic Activity, 1988 (1988), 141–195.CrossRefGoogle Scholar
Freyberger, J.; Neuhierl, A.; and Weber, M.. “Dissecting Characteristics Nonparametrically.” Review of Financial Studies, 33 (2020), 2326–2377.CrossRefGoogle Scholar
Hadlock, C. J., and Pierce, J. R.. “New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index.” Review of Financial Studies, 23 (2010), 1909–1940.CrossRefGoogle Scholar
Hoberg, G., and Maksimovic, V.. “Redefining Financial Constraints: A Text-Based Analysis.” Review of Financial Studies, 28 (2015), 1312–1352.CrossRefGoogle Scholar
Kaplan, S. N., and Zingales, L.. “Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?” Quarterly Journal of Economics, 112 (1997), 169–215.CrossRefGoogle Scholar
Kelly, B. T.; Pruitt, S.; and Su, Y.. “Characteristics are Covariances: A Unified Model of Risk and Return.” Journal of Financial Economics, 134 (2019), 501–524.CrossRefGoogle Scholar
Kiyotaki, N., and Moore, J.. “Credit Cycles.” Journal of Political Economy, 105 (1997), 211–248.CrossRefGoogle Scholar
Lamont, O.; Polk, C.; and Saaá-Requejo, J.. “Financial Constraints and Stock Returns.” Review of Financial Studies, 14 (2001), 529–554.CrossRefGoogle Scholar
Matsa, D. A. “Capital Structure as a Strategic Variable: Evidence from Collective Bargaining.” Journal of Finance, 65 (2010), 1197–1232.CrossRefGoogle Scholar
McCahery, J. A.; Sautner, Z.; and Starks, L. T.. “Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.” Journal of Finance, 71 (2016), 2905–2932.CrossRefGoogle Scholar
Picard, R. R., and Cook, R. D.. “Cross-Validation of Regression Models.” Journal of the American Statistical Association, 79 (1984), 575–583.CrossRefGoogle Scholar
Qiu, L., and Welch, I.. “Investor Sentiment Measures.” NBER Working Paper Series 10794 (2004).CrossRefGoogle Scholar
Rauh, J. D. “Investment and Financing Constraints: Evidence from the Funding of Corporate Pension Plans.” Journal of Finance, 61 (2006), 33–71.CrossRefGoogle Scholar
Shao, J. “Linear Model Selection by Cross-Validation.” Journal of the American Statistical Association, 88 (1993), 486–494.CrossRefGoogle Scholar
Stiglitz, J. E., and Weiss, A.. “Credit Rationing in Markets with Imperfect Information.” American Economic Review, 71 (1981), 393–410.Google Scholar
Tirole, J. The Theory of Corporate Finance. Princeton: Princeton University Press (2006).Google Scholar
Welch, I. “The Wisdom of the Robinhood Crowd.” Journal of Finance, 77 (2022), 1489–1527.CrossRefGoogle Scholar
Whited, T. M., and Wu, G.. “Financial Constraints Risk.” Review of Financial Studies, 19 (2006), 531–559.CrossRefGoogle Scholar
Supplementary material: PDF

Linn and Weagley supplementary material

Linn and Weagley supplementary material

Download Linn and Weagley supplementary material(PDF)
PDF 746.5 KB