Financial Constraints and Industry Dynamics

It is well-established that financially constrained firms scale down their investment activity. The lost investment opportunities, however, could potentially be captured by other firms that are less financially constrained. We test this proposition using the Reg SHO pilot regulation, which relaxed short-selling constraints for about 30% of firms and thus tightened their financial constraints. Following the introduction of the regulation, pilot firms indeed reduced their investments, while their direct competitors increased their investments, expanded their market share, and became more profitable. We conclude that opportunities lost due to financial constraints could be salvaged by competing firms.