When firms are able to pledge their assets as collateral, investment and borrowing become endogenous: pledgeable assets support more borrowings that in turn allow for further investment in pledgeable assets. We show that this credit multiplier has an important impact on investment when firms face credit constraints: investment-cash flow sensitivities are increasing in the degree of tangibility of constrained firms' assets. If firms are unconstrained, however, investment-cash flow sensitivities are unaffected by asset tangibility. Crucially, asset tangibility itself may determine whether a firm faces credit constraints - firms with more tangible assets may have greater access to external funds. This implies that the relationship between capital spending and cash flows is non-monotonic in the firm's asset tangibility. Our theory allows us to use a differences-in-differences approach to identify the effect of financing frictions on corporate investment: we compare the differential effect of asset tangibility on the sensitivity of investment to cash flow across different regimes of financial constraints. We implement this testing strategy on a large sample of manufacturing firms drawn from COMPUSTAT between 1985 and 2000. Our tests allow for the endogeneity of the firm's credit status, with asset tangibility influencing whether a firm is classified as credit constrained or unconstrained in a switching regression framework. The data strongly support our hypothesis about the role of asset tangibility on corporate investment under financial constraints.
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Length: Date of creation: Mar 2006 Date of revision: Handle: RePEc:nbr:nberwo:12087
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Find related papers by JEL classification: G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
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References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Kiyotaki, Nobuhiro & Moore, John, 1997.
"Credit Cycles,"
Journal of Political Economy,
University of Chicago Press, vol. 105(2), pages 211-48, April.
Other versions:
Nobuhiro Kiyotaki & John Moore, 1995.
"Credit Cycles,"
NBER Working Papers
5083, National Bureau of Economic Research, Inc.
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John Moore & Nobuhiro Kiyotaki, .
"Credit Cycles,"
Discussion Papers
1995-5, Edinburgh School of Economics, University of Edinburgh.
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