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Are financing constraints binding for investment? Evidence from a natural experiment

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  • Bilicka, Katarzyna

Abstract

This paper shows that the availability of cash flows dominates the effects of cost of capital for investment at the firm level. Using an exogenous tax reform in Canada as a quasi-natural experiment, I find that a temporary and unexpected increase in the cost of capital for firms with low availability of retained earnings has no effect on investment of those firms. A subsequent direct increase in the availability of cash flows has large effects on investment. This suggests that internal financing constraints are binding for firms, as they prefer to use low cost retained earnings to finance their investment.

Suggested Citation

  • Bilicka, Katarzyna, 2020. "Are financing constraints binding for investment? Evidence from a natural experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 177(C), pages 618-640.
    • Handle: RePEc:eee:jeborg:v:177:y:2020:i:c:p:618-640
    DOI: 10.1016/j.jebo.2020.06.029
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    More about this item

    Keywords

    Investment; Financing constraints; Retained earnings; Income trusts;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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