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Moral Hazard and Investment-Cash-Flow Sensitivity

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  • Rui Li

    (University of Massachusetts Boston)

  • Kai Li

    (Hong Kong University of Science and Technology)

  • Hengjie Ai

    (University of Minnesota)

Abstract

We develop a dynamic model of investment with moral hazard to provide a micro-foundation for financing constraints. In the model, standard investment-cash-flow sensitivity regressions will find a small coefficient on Tobin's Q and a large and significant coefficient on cash flow. Our calibration replicates the empirical fact that larger and more mature firms are less financially constrained but have higher investment-cash-flow sensitivity. Our theory therefore resolves the long-standing puzzle of the existence of the investment-cash-flow sensitivity and the seemingly weak relationship between investment-cash-flow sensitivity and the severity of financing constraints documented by Kaplan and Zingales (1997) and many others.

Suggested Citation

  • Rui Li & Kai Li & Hengjie Ai, 2017. "Moral Hazard and Investment-Cash-Flow Sensitivity," 2017 Meeting Papers 410, Society for Economic Dynamics.
    • Handle: RePEc:red:sed017:410
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    References listed on IDEAS

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