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Evidence on the role of cash flow for investment

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  • Simon Gilchrist
  • Charles P. Himmelberg

Abstract

Recent work in macroeconomics argues that imperfection in captial markets may lead to business cycle fluctuations by propogating relatively modest shoks. Evidence for such a mechanism (also known as the "financial accelerator") consists largely of firm-level studies showing that cash flow is an important predictor of investment. But this evidence is often viewed with skepticism because cash flow is also a good indicator of investment opportunities. In this paper, we develop a framework for estimating the extent to which the predictive power of cash flow can be attributed to its role as a "fundamental" versus its role in alleviating credit frictions. For firms with access to commercial paper and bond markets, we find that the perfect capital markets model of investment can fully account for the role of cash flow. For firms with only limited access to capital markets (as indicated by lack of participation in public debt markets) however, investment appears to be ! "excessively" sensitive to fluctuations in cash flow. These results thus clarify the role of cash flow in investment equations and provide support for the existence of a financial accelerator.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 93-7.

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Date of creation: 1993
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Publication status: Published in Journal of Monetary Economics, December 1995, v. 36, iss. 3, pp. 541-72
Handle: RePEc:fip:fedgfe:93-7

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Keywords: Cash flow ; Investments;

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References

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