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Keywords:

  • corporate finance;
  • small business finance;
  • financial constraints;
  • entropy econometrics;
  • slope heterogeneity

Abstract:  We evaluate two models commonly used for measuring financial constraints in their ability to discriminate between constrained and unconstrained firms. We compute firm-specific estimates for the cash flow sensitivity of investment (CFSI), and the cash flow sensitivity of cash (CFSC) and provide a framework that summarizes the performance of each model into a single numerical metric. We argue that this ‘ex-post’ approach provides interesting advantages over the traditional operationalization, in which firms are classified ‘ex-ante’ on a theoretical basis. Our findings suggest the superiority of the CFSI model over the CFSC model for a sample of manufacturing SMEs in Belgium.