Financial Constraints and Markups

We analyze the effects of financial constraints on markups. Using a firm-level dataset from Japan, we first find that financially constrained firms decreased markups and this effect was heightened during the Global Financial Crisis. Second, we find that financially constrained firms decreased inventories and tangible capital investment. These results are consistent with the liquidity management hypothesis that posits that financially constrained firms lower prices to shed inventories, but not with the customer market hypothesis that predicts that constrained firms raise prices to invest less in the customer base and decrease their market shares. Third, although the extent to which the dispersion in markups due to financial constraints results in aggregate TFP losses through inefficient resource allocation is economically small, the magnitude almost doubled during the Global Financial Crisis. Our results indicate that financial constraints matter for product market competition as well as investment.