The effect of financing constraints on risk

We provide evidence on the causal link between financing constraints and the risk of corporate cash flows and returns. For identification, we compare public US firms in the same industry, location, and size quintile, but whose access to bank credit was differentially affected by WorldCom’s demise in 2002. A credit shortage induces a permanent increase in the volatility and skewness of operating cash flows and an increase in the correlation between firm stock and market returns. We document how firms’ cash, payout, and investment policies respond endogenously to mitigate the impact of constraints on risk.