Investment-Cash Flow Sensitivities: Constrained Versus Unconstrained Firms
70 Pages Posted: 27 May 2002
Date Written: December 2002
From the existing literature, it is not clear what effect financial constraints have on the sensitivity of firms' investment to their cash flow. Conflicting results are due to the use of different criteria for identifying financially constrained firms. I propose an explanation that reconciles the conflicting empirical evidence. I present two models: the unconstrained model in which firms can raise funds on external markets and the constrained model in which firms cannot do so. From these two models, I generate a panel of data, including investment and cash flow series. I find that the sensitivity of investment to cash flow is lower for firms described by the constrained model than for firms described by the unconstrained model, consistent with Kaplan and Zingales's (1997) result. I also find in my generated panel of data that the sensitivity of investment to cash flow is higher for low dividend firms than for high dividend firms, consistent with Fazzari, Hubbard, and Petersen's (1988) result.
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