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The effect of cash flow on investment: an empirical test of the balance sheet theory

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  • Ola Melander

    (Sveriges Riksbank)

  • Maria Sandström

    (Uppsala University)

  • Erik Schedvin

    (Sveriges Riksbank)

Abstract

Using a large data set on investments and accounting information for private firms, we put the balance sheet theory to test. We find that firm cash flow has a positive impact on investment and that the effect is enhanced for firms which are more likely to be financially constrained. We also find that the investment-cash flow sensitivity is significantly larger and more persistent during the first half of our sample period, which includes a severe banking crisis and recession. Our results suggest that financial constraints matter more in periods characterized by adverse economic conditions.

Suggested Citation

  • Ola Melander & Maria Sandström & Erik Schedvin, 2017. "The effect of cash flow on investment: an empirical test of the balance sheet theory," Empirical Economics, Springer, vol. 53(2), pages 695-716, September.
    • Handle: RePEc:spr:empeco:v:53:y:2017:i:2:d:10.1007_s00181-016-1136-y
    DOI: 10.1007/s00181-016-1136-y
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    More about this item

    Keywords

    Financial frictions; Balance sheet channel; Financial accelerator; Investment; Cash flow;
    All these keywords.

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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