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Do Financing Constraints Explain Why Investment is Correlated with Cash Flow?

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  • Steven N. Kaplan
  • Luigi Zingales

Abstract

This paper investigates the sources of the correlation between corporate cash flow and investment by undertaking an in-depth analysis of the 49 low-dividend firms identified by Fazzari, Hubbard, and Petersen (1988) as having an unusually high investment-cash flow sensitivity. We find that in only 15% of firm-years is there some question as to a firm's ability to access internal or external funds to increase investment. Strikingly, those firms that appear less financially constrained exhibit a significantly greater investment- cash flow sensitivity than firms that appear more financially constrained. We find this pattern for the entire sample period, for sub-periods, and for individual years. The results indicate that a higher sensitivity cannot be interpreted as evidence that a firm is more financially constrained. We discuss reasons and provide evidence why the opposite may be true. These findings challenge much of the existing evidence on the effects of financial constraints.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5267.

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Date of creation: Sep 1995
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Publication status: published as Quarterly Journal of Economics, feb.1997, 169-215.
Handle: RePEc:nbr:nberwo:5267

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  1. Toni M. Whited, 1990. "Debt, liquidity constraints, and corporate investment: evidence from panel data," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 114, Board of Governors of the Federal Reserve System (U.S.).
  2. Sanford J. Grossman & Oliver D. Hart, 1982. "Corporate Financial Structure and Managerial Incentives," NBER Chapters, in: The Economics of Information and Uncertainty, pages 107-140 National Bureau of Economic Research, Inc.
  3. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, American Finance Association, vol. 39(3), pages 575-92, July.
  4. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Simon G. Gilchrist & Ben Bernanke & Mark Gertler, 1994. "The financial accelerator and the flight to quality," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 94-18, Board of Governors of the Federal Reserve System (U.S.).
  6. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, American Economic Association, vol. 85(3), pages 567-85, June.
  7. Oliner, Stephen D & Rudebusch, Glenn D, 1992. "Sources of the Financing Hierarchy for Business Investment," The Review of Economics and Statistics, MIT Press, vol. 74(4), pages 643-54, November.
  8. Steven Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1987. "Financing Constraints and Corporate Investment," NBER Working Papers 2387, National Bureau of Economic Research, Inc.
  9. Olivier J. Blanchard & Florencio Lopez-de-Silane, 1993. "What do Firms do with Cash Windfalls?," NBER Working Papers 4258, National Bureau of Economic Research, Inc.
  10. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
  11. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, Elsevier, vol. 3(4), pages 305-360, October.
  12. T. Jappelli & J-S Pischke & N.S. Souleles, 1995. "Testing for Liquidity Constraints in Euler Equations with Complementary Data Sources," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 95-19, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Stephen Bond & Costas Meghir, 1990. "Dynamic Investment Models and the Firm's Financial Policy," CEPR Financial Markets Paper, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ 0013, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
  14. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
  15. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
  16. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1989. "Corporate structure, liquidity, and investment: evidence from Japanese industrial groups," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 82, Board of Governors of the Federal Reserve System (U.S.).
  17. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers, Columbia - Graduate School of Business 95-29, Columbia - Graduate School of Business.
  18. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, Elsevier, vol. 13(2), pages 187-221, June.
  19. Douglas W. Diamond, 1994. "Corporate capital structure: the control roles of bank and public debt with taxes and costly bankruptcy," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 11-37.
  20. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  21. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, American Finance Association, vol. 40(4), pages 1031-51, September.
  22. Anil K. Kashyap & Owen A. Lamont & Jeremy C. Stein, 1993. "Credit conditions and the cyclical behavior of inventories," Working Paper Series, Macroeconomic Issues, Federal Reserve Bank of Chicago 93-7, Federal Reserve Bank of Chicago.
  23. R. Glenn Hubbard & Anil K Kashyap & Toni M. Whited, 1993. "Internal Finance and Firm Investment," NBER Working Papers 4392, National Bureau of Economic Research, Inc.
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