PDi and LDi are aimed at testing the incidence of adverse selection: whether firms in poor financial health and/or facing liquidity constraints are more likely to seek and get access to bank credit. In the case of the liquidity dummy there is no ambiguity about the causality and the interpretation of the results in terms of adverse selection. However, in the case of the profitability dummy, again we cannot fully eliminate the endogeneity problem because – as mentioned before – firm’s profit/loss position may affect also bank’s decision to extend the loan. In order to get around the reverse causality.
