The Sensitivity of Investment to Cash Flow: An Explanation Based on the Growth-Type-Aligned Financing Hierarchy

Abstract

We find the investment-cash-flow-sensitivity (ICFS) decreases with a firm’s asymmetric informational imperfection about growth (AI), a variable highly persistent over time. Firms with distinctly initial AI have distinct future investment styles and financing patterns. Higher initial AI predicts an investment style with more R&D intensity and a financing pattern with more equity than debt. Types of asymmetric information (about growth vs. assets-in-place) affect external finance so that growth uncertainty appears to facilitate rather than suppress equity financing. These findings are consistent with a growth-type explanation for ICFS and do not support the proposition that informational imperfection generally imposes financial constraints.

Keywords: Investment, Growth type, Informational imperfection, Agency Conflict, Financing Hierarchy, Financial constraint

JEL Classification: G30, G31, G32, D92