New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index

Review of Financial Studies (Impact Factor: 4.75). 04/2010; 23(5):1909-1940. DOI: 10.1093/rfs/hhq009
Source: RePEc

ABSTRACT We collect detailed qualitative information from financial filings to categorize financial constraints for a random sample
of firms from 1995 to 2004. Using this categorization, we estimate ordered logit models predicting constraints as a function
of different quantitative factors. Our findings cast serious doubt on the validity of the KZ index as a measure of financial
constraints, while offering mixed evidence on the validity of other common measures of constraints. We find that firm size
and age are particularly useful predictors of financial constraint levels, and we propose a measure of financial constraints
that is based solely on these firm characteristics.

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    • "First, the zero-leverage firms in our sample (column (1)) are significantly smaller and younger than the levered and matched firms (columns (2) and (3)). These findings are in line with the financial constraint hypothesis because small and young firms are most likely to be credit-constrained (Hadlock and Pierce, 2010). Second, the zero-leverage firms have considerably more valuable growth opportunities than the levered and matched firms. "
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    ABSTRACT: This paper examines why some firms have no debt in their capital structures despite the potential benefits of debt financing. It adds new insights to this zero-leverage phenomenon by addressing two unexplored questions: Does a firm have zero leverage as a consequence of financial constraints or because of a strategic decision to mitigate underinvestment incentives and preserve financial flexibility? Is the decision to follow a zero-leverage policy affected by macroeconomic conditions? Analyzing a new sample of UK firms over the period 1980-2007, we show that the zero-leverage policy is prevalent but that zero-leverage firms are not homogeneous. There are two distinct groups of unlevered firms with different levels of constraints as measured by their dividend policy, namely payers and non-payers. Importantly, we find new evidence that these groups have different motives for eschewing debt. Firms in the second group (non-payers) have zero leverage mainly due to financial constraints. Firms in the first group (payers) deliberately eschew debt to mitigate investment distortions, as predicted by the underinvestment and financial flexibility hypotheses. Macroeconomic conditions have a significant effect on the zero-leverage decision, especially for this less constrained group.
    International Review of Financial Analysis 12/2013; 30. DOI:10.1016/j.irfa.2013.08.007 · 0.88 Impact Factor
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    • "Thus, we do not expect firms to issue shares to employees to conserve cash unless their access to external equity is limited (very costly). Young and small firms tend to have more costly (difficult) access to external equity (Hadlock and Pierce, 2010). Thus, we conjecture when younger and smaller firms adopt ESOPs, the cash conservation motivation is more likely to be at work and wages fall subsequent to the adoption of ESOPs. "
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    ABSTRACT: Firms with broad-based employee share ownership plans often claim ESOPs increase productivity by improving employee incentives. Do they? The answer depends on the number of employees and the size of ESOP. Small ESOPs comprising less than 5% of shares, granted by firms with moderate employee size, increase the economic pie, benefitting both employees and shareholders. The effects are much weaker when there are too many employees to mitigate free-riding. Although some large ESOPs increase productivity and employee compensation, the average impacts are small, because they are often implemented for non-incentive purposes, such as conserving cash by substituting wages with employee shares or forming a worker-management alliance to thwart takeover bids.
    The Journal of Finance 04/2013; 69(3). DOI:10.2139/ssrn.1823745 · 4.22 Impact Factor
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    • "Using the idea young firms have a limited credit history, Martinelli (1997) shows that lenders limit the scale of lending to young firms. Using management comments in SEC filings, Hadlock and Pierce (2010) categorize firms into five levels of financial constraints. They test which variables explain management's perception of their level of financial constraints and compare their findings to measures previously used in the literature. "
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    ABSTRACT: We decompose the effect of changing macroeconomic conditions and firm characteristics on the market value of U.S. firms’ cash holdings from 1971 through 2009. We find that, ceteris paribus, the market value of a $1 increase in cash holdings is (i) 11.4‹ higher during economic expansions, (ii) 12.3‹ higher for young firms, (iii) 13.2‹ higher for firms with high cash flow volatility, (iv) 23.1‹ higher for small firms that engage in research and development, (v) 17.7‹ higher for firms with high capital expenditures, and (vi) 23.4‹ higher for firms in that engage in R&D and are in top tercile of capital expenditures. Overall, our evidence suggests the marginal value of cash is positively associated with expanding economic states, investment opportunities, and measures of firm-level financial constraints.
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