Uncovering Financial Constraints

Matthew Linn and Daniel Weagley

We use a random forest model to classify firms’ financial constraints using only financial variables. Our methodology expands the range of classified firms compared to text-based measures while maintaining similar levels of informativeness. We construct two versions of our constraint measures, one using many firm characteristics and the other using a small set of more primitive characteristics. Using our measures, we find that institutional investors hold a lower percentage of shares in equity-focused constrained firms, while retail investors show a preference for them. Equity issuance and investment of constrained firms also increases during periods of high investor sentiment.