Evidence on Cash Flow Sensitivity of Cash

Posted: 17 Dec 2011

See all articles by Vikash Gautam

Vikash Gautam

Indira Gandhi Institute of Development Research (IGIDR)

Ashish Singh

Azim Premji University

Date Written: October 29, 2011


A major criticism against the use of investment-cash flow sensitivity to measure finance constraint of firms is that cash flows, besides capturing information on internal liquidity, also capture information on growth opportunities of firms. Moreover, some researchers also point to the measurement error in using Tobin’s average q as proxy for growth opportunities of firms. To overcome these problems, we use cash-cash flow sensitivity, as suggested by Bruinshoofd (2003) and Almeida, Campello and Weisbach (2004), to identify financially constrained Indian manufacturing firms. We use an endogenous regime switching regression to analyze the determinants of cash holdings by firms. This method, besides estimating the cash holding function, also estimates a switching function. This helps in taking care of two important issues which the literature on cash-cash flow sensitivity largely ignores: first, we do not require the metric measuring finance constraint to increase monotonically with the sorting variables used in the switching function. Second, we allow firms to endogenously change regime over the sample period.

Keywords: investment-cash flow sensitivity, internal liquidity, growth opportunities, cash-cash flow sensitivity, endogenous regime switching regression

JEL Classification: D82, G14, G31, G32

Suggested Citation

Gautam, Vikash and Singh, Ashish, Evidence on Cash Flow Sensitivity of Cash (October 29, 2011). Available at SSRN: https://ssrn.com/abstract=1973370

Vikash Gautam (Contact Author)

Indira Gandhi Institute of Development Research (IGIDR) ( email )

Gen A.K. Vaidya Marg Santoshnagar
Goregaon (East)
Mumbai, Maharashtra 400065

Ashish Singh

Azim Premji University ( email )

Electronic City
Hosur Road (Beside NICE Road)
Bangalore, 560100

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