How Costly Is External Financing? Evidence from a Structural Estimation




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    • Christopher Hennessy is at the University of California, Berkeley, and Toni Whited is at the University of Wisconsin, Madison. An earlier version of this paper was circulated under the title, “Beyond Investment-Cash Flow Sensitivities: Using Indirect Inference to Estimate Costs of External Funds.” We thank seminar participants at Carnegie Mellon University, University of Southern California, Kellogg, University of Colorado, University of Texas at Austin, University of Illinois, New York University, University of Maryland, Rochester, the Stockholm Institute for Financial Research, Instituto Tecnológico Autónomo de México, the University of British Columbia Summer Finance Conference, the Western Finance Association Annual Meetings, and the European Finance Association Annual Meetings. Special thanks to Lisa Kramer, Nathalie Moyen, Michael Roberts, an associate editor, and two anonymous referees for detailed feedback.


We apply simulated method of moments to a dynamic model to infer the magnitude of financing costs. The model features endogenous investment, distributions, leverage, and default. The corporation faces taxation, costly bankruptcy, and linear-quadratic equity flotation costs. For large (small) firms, estimated marginal equity flotation costs start at 5.0% (10.7%) and bankruptcy costs equal to 8.4% (15.1%) of capital. Estimated financing frictions are higher for low-dividend firms and those identified as constrained by the Cleary and Whited-Wu indexes. In simulated data, many common proxies for financing constraints actually decrease when we increase financing cost parameters.