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

Is the risk of product market predation a cost of disclosure?

“…Large firms typically have more diverse operations and more financial flexibility than small firms (e.g., Hadlock and Pierce, 2010), which means that predation on a large firm, whether by another large firm or by a number of small firms, is relatively costly and less likely to succeed. 14 In contrast, small firms can be targeted by other small firms or by large firms.…”

“…In Section 6.3.1, I take advantage of the stepwise increase in filing compliance between 2004 and 2006 to 30 One possible interpretation of the results in Figure 4 Panels A and B is that relative size and relative operating profitability merely refine the measure of financial constraint. Put differently, the cross-sectional tests in Panels A and B may only capture differences across firms in the levels of size and operating profitability -determinants of financial constraint (Campello et al, 2010;Hadlock and Pierce, 2010) -rather than relative-to-rival differences per se, which are also important to the predictions in H2 and H3. In untabulated tests, I add the interaction of industry adjusted leverage net of cash and the natural log of total assets to the estimation in Table 4, column 1 and the interaction of industry adjusted leverage net of cash and ROA to the estimation in Table 4, column 2, where ROA equals the operating profitability of the firm scaled by total assets, without industry adjustment.…”

“…Hadlock and Pierce (2010) and Kaplan and Zingales (1997) find that leverage is strongly positively related to the probability that public firm managers make qualitative disclosures in SEC filings indicating financial constraint, and Whited and Wu (2006) and Lamont et al (2001) positively weight leverage in constructing parsimonious models of financial constraint. Graham and Harvey (2001) show that managers view financial flexibility as decreasing in debt.…”

“…For example, basic income statement and balance sheet disclosures contain information about a firm's size, leverage, liquidity, and operating performance, all of which are determinants of financial constraint and, therefore, the firm's vulnerability to predation (Hadlock and Pierce, 2010). By withholding financial disclosures, then, firms can raise a potential predator's uncertainty about the efficacy of a predatory product market strategy, including the financial resources, production capacity, and time needed for predation to be successful.…”

“…The latter requirement ensures that systematically associated with financial constraint (e.g., Hadlock and Pierce, 2010). As a result, I cannot guarantee that these proxies capture distinct constructs.…”