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The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities

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  • VLADIMIR A. GATCHEV
  • TODD PULVINO
  • VEFA TARHAN

Abstract

We develop a dynamic multiequation model where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates, and that models that do not acknowledge the interdependence among decision variables produce inefficient estimates and provide an incomplete and potentially misleading view of financial behavior. We use our model to examine whether firms are constrained from accessing capital markets. Unlike static single‐equation studies that find firms underinvest given cash flow shortfalls, we conclude that firms maintain investment by borrowing.

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  • Vladimir A. Gatchev & Todd Pulvino & Vefa Tarhan, 2010. "The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities," Journal of Finance, American Finance Association, vol. 65(2), pages 725-763, April.
    • Handle: RePEc:bla:jfinan:v:65:y:2010:i:2:p:725-763
    DOI: 10.1111/j.1540-6261.2009.01549.x
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