Financial Constraints and Stock Returns

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