Information Production, Cash Flow and Corporate Investment
48 Pages Posted: 8 Dec 2001
Date Written: August 2002
We use a simple information-based model of corporate investment to determine when investment will be sensitive to cash flow. The key cross-sectional prediction of the model is that investment-cash flow sensitivity will be stronger for firms with more informative stock prices, higher cash flow volatility and smaller divergence in opinions among the informed traders. Our model offers a market microstructure-based explanation about the investment-cash flow sensitivity other than the popular "financing constraint" hypothesis proposed by Fazzari, Hubbard, and Petersen (1988). Using financial analysts following a firm as a measure for informed traders, we find strong support for the model predictions. In particular, firms that are intensively covered by analysts have investment that is much more sensitive to cash flow than firms with less analyst coverage. We also verify several other predictions of the model.
Keywords: Information, investment-cash flow sensitivity, financial analyst, Market Microstructure
JEL Classification: G31, G14
Suggested Citation: Suggested Citation