The Intertemporal and Interdependent Nature of Financial Decisions: An Applicacation to Cash Flow Sensitivities

54 Pages Posted: 18 Feb 2009 Last revised: 25 Feb 2010

See all articles by Vladimir A. Gatchev

Vladimir A. Gatchev

University of Central Florida - Department of Finance

Todd C. Pulvino

AQR Capital Management, LLC; CNH Partners

Vefa Tarhan

Loyola University of Chicago - School of Business Administration; Northwestern University - Kellogg Graduate School of Management

Date Written: February 15, 2009

Abstract

Empirical studies of firms' financing, investment, and payout policies routinely examine these policies in isolation. In this paper we develop a dynamic multi-equation model where firms make financing and investment decisions jointly subject to the constraint that sources of cash must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates. We also argue that models that do not acknowledge the interdependence among decision variables produce inefficient coefficient estimates and provide an incomplete and potentially misleading view of firms' financial behavior. We use our model to study the relationship between investment and cash flow. Unlike static single-equation studies that conclude that firms react to cash flow shocks by changing investments, we find that regardless of financial health, firms react by changing leverage.

Keywords: Capital market frictions, Financing and investment decisions, Cash flow sensitivities

JEL Classification: G31, G32, G10

Suggested Citation

Gatchev, Vladimir A. and Pulvino, Todd C. and Tarhan, Vefa, The Intertemporal and Interdependent Nature of Financial Decisions: An Applicacation to Cash Flow Sensitivities (February 15, 2009). Available at SSRN: https://ssrn.com/abstract=1344009 or http://dx.doi.org/10.2139/ssrn.1344009

Vladimir A. Gatchev

University of Central Florida - Department of Finance ( email )

Orlando, FL 32816-1400
United States
(407) 823-3694 (Phone)
(407) 823-6676 (Fax)

HOME PAGE: http://www.bus.ucf.edu/vgatchev/

Todd C. Pulvino

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

CNH Partners ( email )

2 Greenwich Plaza
1st Floor
Greenwich, CT 06830
United States
203-742-3002 (Phone)
203-742-3072 (Fax)

Vefa Tarhan (Contact Author)

Loyola University of Chicago - School of Business Administration ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States

Northwestern University - Kellogg Graduate School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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