Debt, Liquidity Constraints, and Corporate Investment: Evidence from Panel Data



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    • Department of Economics, Boston College. John Barkoulas provided able and dedicated research assistance. I would like to thank Larry Ball, Ben Bernanke, Alan Blinder, Mike Boozer, John Campbell, Bill Gentry, Anil Kashyap, an anonymous referee, and the editor for helpful comments and suggestions. The National Science Foundation provided financial support. An earlier version of this paper appears as Chapter 2 of my Princeton Ph.D. dissertation.


This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. I test this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained groups, but is rejected for the others.