The Business Cycle, Investor Sentiment, and Costly External Finance
53 Pages Posted: 20 Sep 2009 Last revised: 7 Aug 2013
Date Written: June 20, 2012
The recent financial crisis highlights the importance of understanding how financial market conditions impact the real economy. We ask whether access to external finance typically varies over time, and if so what the effects are on investment and employment. Consistent with time-varying external finance costs, we find that both investment and employment are less sensitive to Tobin’s q and more sensitive to cash flow during recessions and periods of low investor sentiment. Share issuance and debt issuance both play roles in causing these effects, although our findings suggest that share issuance plays a bigger role. Alternative tests, which do not rely on q and cash flow sensitivities, support the idea that both low sentiment and recessions increase external finance costs, which in turn limit investment and employment.
Keywords: Business Cycle, Recession, Investor Sentiment, Financial Constraint, Market Efficiency, Corporate Investment
JEL Classification: E32, E44, G10
Suggested Citation: Suggested Citation