Determinants of financial constraint: a text-based financial constraint index approach

ABSTRACT

The study employs a text-based Phrase Matching Method (PMM) index for the financial constraint to identify the key determinants of financial constraints. The study finds that conventional determinants of financial constraint like size, age, dividend payment, long-term borrowing, credit rating, group membership, current ratio, price-to-book ratio, debt-to-equity ratio, capital expenditure, cash flow, and sales growth play a significant role in determining the financial constraint of Indian manufacturing firms. Apart from the conventional determinants, the study also finds that factors like tangibility, R and D intensity, and corporate governance also play an important role in determining financial constraints.

KEYWORDS:

• Financial constraint
• text-based index
• firm characteristics
• dynamic model

JEL classification:

• C23
• G32

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

Data is available on request.

Notes

1. The study used the definition used by CMIE prowessIQ data base to measure price to book ratio.

2. Tangibility = 0.715 * Receivables + 0.547 * Inventory + 0.535 * Capital.

3. Capital expenditure is measured as addition to gross fixed assets scaled by total assets. For current ratio and debt-to-equity ratio, we used the definition given by CMIE prowessIQ database. Sales growth is measured as (Sales_t – Sales_t-1)/Sales_t-1;

4. The PMM index recorded an accuracy and F score exceeding 80%, whereas all conventional accounting-based indices yielded accuracy and F scores below 70%.

5. Following the literature, we classified the top 30% of firm years with highest PMM index value as financially constrained and the remaining firm years are classified as financially unconstrained.

6. https://economictimes.indiatimes.com/small-biz/sme-sector/et-msme-day-2023-how-can-msmes-in-manufacturing-gear-up-to-be-future-ready/articleshow/101180893.cms.

7. https://economictimes.indiatimes.com/news/india/indias-rd-spends-amongst-the-lowest-in-the-world-niti-aayog-study/articleshow/93024586.cms.

8. https://www.drishtiias.com/daily-updates/daily-news-editorials/r-d-inadequacies-in-india#:~:text=In%20India%2C%20the%20government%20undertakes,0.7%25%20of%20GDP%20on%20R%26D.

Additional information

Notes on contributors

Amal Jose

Amal Jose is currently doing his PhD under the supervision of Dr. Saumitra Bhaduri at the Madras School of Economics. His areas of interest are asset pricing, corporate governance, risk management and economic policy analysis.

Saumitra Bhaduri

Saumitra Bhaduri is a professor and dean of student affairs at Madras School of Economics. His areas of interest are economic policy analysis, quantitative research, corporate finance, market microstructure, and risk management. He has published his papers in journals like Emerging Markets Review, Applied Financial Economics Letters, Journal of Economics and Finance, International Review of Economics & Finance, and Review of Behavioral Finance among others