How Costly Is External Financing? Evidence from a Structural Estimation

TLDR

The study uses simulated method of moments on a dynamic model to estimate the magnitude of financing costs. The dynamic model incorporates endogenous investment, leverage, default, taxation, bankruptcy costs, and linear‑quadratic equity flotation costs. Estimated marginal equity flotation costs are 5.0% for large firms and 10.7% for small firms, while bankruptcy costs are 8.4% and 15.1% of capital, respectively; financing frictions are higher for low‑dividend and constrained firms, and common proxies for constraints decline as financing costs rise.

Abstract

ABSTRACT 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.