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Time to build capital: Revisiting investment-cash-flow sensitivities

  • Tsoukalas, John D.

A large body of empirical work has established the significance of cash flow in explaining investment dynamics. This finding is further taken as evidence of capital market imperfections. We show, using a perfect capital markets model, that time-to-build for capital projects creates an investment-cash-flow sensitivity as found in empirical studies that may not be indicative of capital market frictions. The result is due to mis-specification present in empirical investment-q equations under time-to-build investment. In addition, time aggregation error can give rise to cash-flow effects independently of the time-to-build effect. Importantly, both errors arise independently of potential measurement error in q. Evidence from a large panel of U.K. manufacturing firms confirms the validity of the time-to-build investment channel.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 35 (2011)
Issue (Month): 7 (July)
Pages: 1000-1016

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Handle: RePEc:eee:dyncon:v:35:y:2011:i:7:p:1000-1016
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