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Firm Investment and Financial Frictions

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  • Christopher F. Baum
  • Mustafa Caglayan
  • Oleksandr Talavera

Abstract

In this paper we investigate the analytical and empirical linkages between firms' capital investment behavior and financial frictions arising from asymmetric information, proxied by firms' liquidity and degree of uncertainty. Measures of intrinsic and extrinsic uncertainty are derived from firms' daily stock returns and S&P 500 index returns along with a CAPM-based risk measure. We employ a panel of U.S. manufacturing firm data obtained from COMPUSTAT over the 1984-2003 period. Financial frictions captured by interactions between firms' cash flow and both intrinsic and CAPM-based measures of uncertainty have a significant negative impact on firms' investment spending, while extrinsic uncertainty has a positive impact.

Suggested Citation

  • Christopher F. Baum & Mustafa Caglayan & Oleksandr Talavera, 2006. "Firm Investment and Financial Frictions," Discussion Papers of DIW Berlin 634, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp634
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    References listed on IDEAS

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    More about this item

    Keywords

    capital investment; asymmetric information; financial frictions; uncertainty; CAPM;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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