What’s in the Text?—A Text-Based Financial Constraint Index for Indian Manufacturing Firms

The paper introduces a text-based index for measuring financial constraints. The study employs a novel phrase-matching algorithm to measure financial constraints. The phrase matching method (PMM) index captures the severity of financial constraints by calculating the percentage of constraint phrases in the annual report. A higher value of the PMM index implies a higher degree of financial constraint and vice versa. The study conducts both statistical and economic validation methods to check the performance of the PMM index in measuring financial constraints. Notably, the test–retest reliability test and fivefold cross-validation test show that the PMM index is an efficient and reliable proxy for measuring financial constraints. Further, using robust validation, the study finds that the PMM index outperforms the conventional financial constraint proxies in capturing the severity of financial constraint. The PMM index has higher accuracy and f-score and predicts liquidity events, such as dividend omission and dividend increase, better than the widely used financial constraint indexes.