Investment, Fundamentals and Finance

54 Pages Posted: 6 Nov 1998 Last revised: 10 Oct 2010

See all articles by Simon Gilchrist

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Charles P. Himmelberg

Goldman, Sachs & Co.

Date Written: July 1998


Financial variables such as cash flow and cash stocks are robust and quantitatively important explanatory variables for investment at the firm-level. A large body of recent empirical work attributes these findings to capital market imperfections. This interpretation is controversial, however, because even in the absence of capital market imperfections, such financial variables may appear as an explanatory variable for investment if they contain information about the expected marginal value of capital. In this paper, we show how structural models of investment with costly external finance can be used to identify and quantify the fundamental' versus the financial' determinants of investment. Our empirical results show that investment responds significantly to both fundamental and financial factors. Point estimates from our structural model imply that, for the average firm in our sample, financial factors raise the overall response of investment to an expansionary shock by 25%, relative to a baseline case where financial frictions are zero. Consistent with theory, small firms and firms without bond ratings show the strongest response to financial factors, while bond-rated firms show little if any response once we control for investment fundamentals.

Suggested Citation

Gilchrist, Simon and Himmelberg, Charles P., Investment, Fundamentals and Finance (July 1998). NBER Working Paper No. w6652. Available at SSRN:

Simon Gilchrist

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Charles P. Himmelberg (Contact Author)

Goldman, Sachs & Co. ( email )

200 West St
New York, NY 10233
917-343-3218 (Phone)

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