This paper examines the relative magnitude of financial versus real frictions by looking at how firms react to quasi-exogenous cash shortfalls to pension assets. To answer the question theoretically, we examine a dynamic model of financing and exogenous cash shortfalls. We find that when financing costs are high, firms adjust on real margins and vice versa. We find that firms optimally avoid costly cash shortfalls, only experiencing these events after serious negative shocks to profits. We also find that commonly used regression tests for the presence of finance constraints can produce false positives. In contrast, regression discontinuity techniques can provide an accurate method for uncovering the existence and magnitudes of finance constraints.
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