Can Capital Adjustment Costs Explain the Decline in Investment-Cash Flow Sensitivity?

53 Pages Posted: 29 Jan 2021

See all articles by Shushu Liao

Shushu Liao

Auckland University of Technology

Ingmar Nolte

Lancaster University - Department of Accounting and Finance

Grzegorz Pawlina

Lancaster University - Department of Accounting and Finance

Date Written: November 13, 2020

Abstract

It is well documented that since at least the 1970s investment-cash flow (I-CF) sensitivity has been decreasing over time to disappear almost completely by the late 2000s. Based on a neoclassical investment model with costly external financing, we show that this pattern can be explained by the gradual increase of capital adjustment costs. The result is corroborated in the supplementary analysis that exploits the cross-country and cross-industry variation of capital adjustment costs, as proxied by the level of technological advancement. More generally, our findings demonstrate that I-CF sensitivity should only be interpreted as a joint measure of financial and real frictions.

Keywords: Adjustment costs, investment-cash flow sensitivity, financing constraints

JEL Classification: E22, G30, G31, G32

Suggested Citation

Liao, Shushu and Nolte, Ingmar and Pawlina, Grzegorz, Can Capital Adjustment Costs Explain the Decline in Investment-Cash Flow Sensitivity? (November 13, 2020). Available at SSRN: https://ssrn.com/abstract=3746210 or http://dx.doi.org/10.2139/ssrn.3746210

Shushu Liao

Auckland University of Technology ( email )

AUT City Campus
Private Bag 92006
Auckland, 1142
New Zealand

Ingmar Nolte

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Grzegorz Pawlina (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+ 44 1524 592834 (Phone)
+ 44 1524 847321 (Fax)

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