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Investment, Financial Factors and Business Fluctuations

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Abstract

This paper investigates the relationship between investment and internal finance by addressing two recent topics within the theory of imperfect capital markets: the financial accelerator hypothesis and the controversy over the source of the investment-cash flow sensitivity. Using a panel of Italian companies, we estimate an empirical model of investment which adds cash flow as a proxy for the availability of internal funds. By testing for parameter constancy across two sub-samples of independent and group-affiliated firms, we find that the relationship between investment and cash flow is more likely to be explained by the hypothesis of asymmetric information on capital markets (under-investment) than by the managerial discretion view (over-investment). Our results also suggest that, at least for independent companies, the investment-cash flow relationship is counter-cyclical, as predicted by the theory of the financial accelerator.

Suggested Citation

  • Laura Rondi & Alessandro Sembenelli, 1997. "Investment, Financial Factors and Business Fluctuations," CERIS Working Paper 199717, CNR-IRCrES Research Institute on Sustainable Economic Growth - Torino (TO) ITALY - former Institute for Economic Research on Firms and Growth - Moncalieri (TO) ITALY.
    • Handle: RePEc:csc:cerisp:199717
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    More about this item

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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