Financial Constraints and Stock Returns

Abstract

We test whether impact of constraints on firm value is observable in returns. We form portfolios of based on observable characteristics related to financial constraints, and test for common covariation in of these firms. Using several different measures of constraints, we find that financially constrained firms' stock move together over time. This constraint factor in is related to not well explained by, other empirically identified factors in asset returns. Constrained firms have remarkably low in our sample period of 1968-1995, both unconditionally and in the context of empirical asset pricing models. Financial constraint help explain returns following initial public offerings and dividend omissions. We find only limited support for the hypothesis that relative performance of financially constrained reflects monetary policy, credit conditions, and business cycles.

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