Cash Flow Sensitivity of Investment

Abstract

Investment cash flow sensitivity is associated with both undervestment when cash flows are low and overinvestment when cash flows are high. The accessibility of external capital is positively correlated with cash flows, intensifying investment cash flow sensitivity. Managers actively counteract the variations in internal and external liquidity by accumulating working capital when liquidity is high and draining it when liquidity is low. These results imply that cash flow sensitive firms face financial constraints, which are binding in low cash flow years. While financial constraints have an economically significant impact on investment timing, cash flow sensitive firms alleviate their effects and, actually, overinvest, on aggregate.

Keywords: Investment cash flow sensitivity, financial constraints, investment, managerial overconfidence

JEL Classification: G30, G31, G32