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The Effect of Financial Development on the Investment-Cash Flow Relationship: Cross-Country Evidence from Europe

  • Becker Bo

    ()

    (Harvard Business School)

  • Sivadasan Jagadeesh

    ()

    (University of Michigan - Ann Arbor)

We investigate if financial development eases firm level financing constraints in a cross-country data set covering much of the European economy. The cash flow sensitivity of investment is lower in countries with better-developed financial markets. To deal with potentially serious biases, we employ a difference-in-difference methodology. Subsidiaries of other firms have access to internal capital markets and hence depend less on the external financial environment. As predicted, the benefit of financial development is smaller in subsidiary firms. This shows that financial development can mitigate financial constraints, and sheds light on the link between financial and economic development.

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Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

Volume (Year): 10 (2010)
Issue (Month): 1 (May)
Pages: 1-49

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Handle: RePEc:bpj:bejeap:v:10:y:2010:i:1:n:43
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