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Moral Hazard and Investment-Cash-Flow Sensitivity

Author

Listed:
  • Hengjie Ai

    (Wisconsin School of Business, University of Wisconsin Madison)

  • Kai Li

    (HSBC Business School, Peking University)

  • Rui Li

    (University of Massachusetts Boston)

Abstract

We develop a dynamic model of investment with moral hazard and 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

  • Hengjie Ai & Kai Li & Rui Li, 2024. "Moral Hazard and Investment-Cash-Flow Sensitivity," Annals of Economics and Finance, Society for AEF, vol. 25(1), pages 143-174, May.
    • Handle: RePEc:cuf:journl:y:2024:v:25:i:1:ailili
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    Financing constraints; Dynamic moral hazard; Q theory; Investment-cash-flow sensitivity;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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