Matthias Buehlmaier is Principal Lecturer in Finance at the University of Hong Kong, and Toni M. Whited is Dale L. Dykema Professor of Business Administration at the University of Michigan. This post is based on their recent article, forthcoming in the Review of Financial Studies.
In our paper, Are Financial Constraints Priced? Evidence from Textual Analysis, forthcoming in the Review of Financial Studies, we develop a new measure of financial constraints based on the narrative portions of company annual reports and use this measure to revisit the question of whether financial constraints affect stock returns. Financial constraints arise from frictions such as information asymmetries that make external funds more costly than internal funds, sometimes prohibitively so. An example of a financially constrained firm is a rapidly growing company that has good investment projects but faces difficulties obtaining all of the necessary outside financing to fund its growth. Although financial constraints are easy to understand on this conceptual level, it remains an empirical challenge to quantify them and thus to understand their implications. For example, the academic literature has produced many measures of financial constraints based on accounting data, but these measures are likely noisy, as accounting statements contain no direct information on potential investment projects or desired financing needs.
