IDEAS home Printed from https://ideas.repec.org/p/bge/wpaper/65.html
   My bibliography  Save this paper

Testing Financing Constraints on Firm Investment Using Variable Capital

Author

Listed:
  • Andrea Caggese

Abstract

A recent literature has criticised the sensitivity of a firm's investment to its own cash flow as an adequate measure of financing constraints. In this paper we develop a new method to detect the presence of financing constraints at firm level. We consider a structural dynamic model of investment with financing imperfections and with both fixed and variable capital. We solve the model and simulate an industry with many firms. We show that the irreversibility of fixed capital is the main reason why the sensitivity of fixed investment to cash flow is not a good measure of financing constraints. Using the fact that variable capital is reversible, we develop a new test of financing constraints based on a reduced form variable capital investment equation. Simulation results show that our test correctly identifies financially constrained firms also when the estimation of firms' investment opportunities is very noisy. Moreover our test is valid regardless of the type of adjustment costs of fixed capital. We confirm empirically the validity of this method on a sample of US companies.

Suggested Citation

  • Andrea Caggese, 2003. "Testing Financing Constraints on Firm Investment Using Variable Capital," Working Papers 65, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:65
    as

    Download full text from publisher

    File URL: http://www.barcelonagse.eu/sites/default/files/working_paper_pdfs/65.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Pratap, Sangeeta, 2003. "Do adjustment costs explain investment-cash flow insensitivity?," Journal of Economic Dynamics and Control, Elsevier, pages 1993-2006.
    2. Jacques Mairesse & Bronwyn H. Hall, 1996. "Estimating the Productivity of Research and Development: An Exploration of GMM Methods Using Data on French & United States Manufacturing Firms," NBER Working Papers 5501, National Bureau of Economic Research, Inc.
    3. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-689, October.
    4. Andrea Caggese, 2001. "Financing constraints, irreversibility and investment dynamics," Economics Working Papers 1008, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2006.
    5. John Shea, 1997. "Instrument Relevance in Multivariate Linear Models: A Simple Measure," The Review of Economics and Statistics, MIT Press, pages 348-352.
    6. Caballero, R.J., 1996. "Fixed Costs: The Demise of Marginal q," Working papers 96-14, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, pages 323-329.
    8. Nathalie Moyen, 2004. "Investment-Cash Flow Sensitivities: Constrained versus Unconstrained Firms," Journal of Finance, American Finance Association, vol. 59(5), pages 2061-2092, October.
    9. Luigi Guiso & Giuseppe Parigi, 1999. "Investment and Demand Uncertainty," The Quarterly Journal of Economics, Oxford University Press, pages 185-227.
    10. Whited, Toni M., 2006. "External finance constraints and the intertemporal pattern of intermittent investment," Journal of Financial Economics, Elsevier, vol. 81(3), pages 467-502, September.
    11. Robert E. Carpenter & Steven M. Fazzari & Bruce C. Petersen, 1998. "Financing Constraints And Inventory Investment: A Comparative Study With High-Frequency Panel Data," The Review of Economics and Statistics, MIT Press, pages 513-519.
    12. Steven N. Kaplan & Luigi Zingales, 2000. "Investment-Cash Flow Sensitivities Are Not Valid Measures of Financing Constraints," The Quarterly Journal of Economics, Oxford University Press, vol. 115(2), pages 707-712.
    13. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, pages 193-225.
    14. Hennessy, Christopher A. & Levy, Amnon & Whited, Toni M., 2007. "Testing Q theory with financing frictions," Journal of Financial Economics, Elsevier, vol. 83(3), pages 691-717, March.
    15. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 1027-1057, October.
    16. Fabiano Schivardi & Roberto Torrini, 2004. "Threshold Effects and Firm Size: the Case of Firing Costs," CEP Discussion Papers dp0633, Centre for Economic Performance, LSE.
    17. Chee K. Ng & Janet Kiholm Smith & Richard L. Smith, 1999. "Evidence on the Determinants of Credit Terms Used in Interfirm Trade," Journal of Finance, American Finance Association, vol. 54(3), pages 1109-1129, June.
    18. Robert E. Carpenter & Bruce C. Petersen, 2002. "Is The Growth Of Small Firms Constrained By Internal Finance?," The Review of Economics and Statistics, MIT Press, pages 298-309.
    19. Eberly, Janice C., 1997. "International evidence on investment and fundamentals," European Economic Review, Elsevier, vol. 41(6), pages 1055-1078, June.
    20. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, pages 29-51.
    21. Lubomír Lízal & Jan Svejnar, 2002. "Investment, Credit Rationing, And The Soft Budget Constraint: Evidence From Czech Panel Data," The Review of Economics and Statistics, MIT Press, pages 353-370.
    22. Stephen Nickell & Sushil Wadhwani, 1991. "Employment Determination in British Industry: Investigations Using Micro-Data," Review of Economic Studies, Oxford University Press, pages 955-969.
    23. Gelos, R. Gaston & Werner, Alejandro M., 2002. "Financial liberalization, credit constraints, and collateral: investment in the Mexican manufacturing sector," Journal of Development Economics, Elsevier, pages 1-27.
    24. Aydogan Alti, 2003. "How Sensitive Is Investment to Cash Flow When Financing Is Frictionless?," Journal of Finance, American Finance Association, vol. 58(2), pages 707-722, April.
    25. Sharpe, Steven A, 1994. "Financial Market Imperfections, Firm Leverage, and the Cyclicality of Employment," American Economic Review, American Economic Association, pages 1060-1074.
    26. Burnside, Craig, 1996. "Production function regressions, returns to scale, and externalities," Journal of Monetary Economics, Elsevier, pages 177-201.
    27. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, pages 141-206.
    28. Green, David A. & Worswick, Christopher, 2012. "Immigrant earnings profiles in the presence of human capital investment: Measuring cohort and macro effects," Labour Economics, Elsevier, pages 241-259.
    29. Sharpe, Steven A, 1994. "Financial Market Imperfections, Firm Leverage, and the Cyclicality of Employment," American Economic Review, American Economic Association, pages 1060-1074.
    30. Simon Gilchrist & Charles Himmelberg, 1999. "Investment: Fundamentals and Finance," NBER Chapters,in: NBER Macroeconomics Annual 1998, volume 13, pages 223-274 National Bureau of Economic Research, Inc.
    31. Haramillo, Fidel & Schiantarelli, Fabio & Weiss, Andrew, 1996. "Capital market imperfections before and after financial liberalization: An Euler equation approach to panel data for Ecuadorian firms," Journal of Development Economics, Elsevier, pages 367-386.
    32. Caballero, Ricardo J., 1999. "Aggregate investment," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 12, pages 813-862 Elsevier.
    33. Stephen Bond, 2000. "Noisy Share Prices and the Q Model of Investment," Econometric Society World Congress 2000 Contributed Papers 1320, Econometric Society.
    34. Caggese, Andrea, 2007. "Financing constraints, irreversibility, and investment dynamics," Journal of Monetary Economics, Elsevier, pages 2102-2130.
    35. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, August.
    36. Janice C. Eberly & Andrew B. Abel, 2004. "Q Theory Without Adjustment Costs & Cash Flow Effects Without Financing Constraints," 2004 Meeting Papers 205, Society for Economic Dynamics.
    37. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, Oxford University Press, vol. 113(1), pages 1-41.
    38. Claudio Piga, 2002. "Debt and Firms' Relationships: The Italian Evidence," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 20(3), pages 267-282, May.
    39. Roberto Basile & Anna Giunta & Jeffrey Nugent, 2003. "Foreign Expansion by Italian Manufacturing Firms in the Nineties: an Ordered Probit Analysis," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 23(1), pages 1-24, August.
    40. Haramillo, Fidel & Schiantarelli, Fabio & Weiss, Andrew, 1996. "Capital market imperfections before and after financial liberalization: An Euler equation approach to panel data for Ecuadorian firms," Journal of Development Economics, Elsevier, pages 367-386.
    41. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, pages 193-225.
    42. Barnett, Steven A. & Sakellaris, Plutarchos, 1998. "Nonlinear response of firm investment to Q:: Testing a model of convex and non-convex adjustment costs1," Journal of Monetary Economics, Elsevier, pages 261-288.
    43. Berger, Philip G. & Ofek, Eli & Swary, Itzhak, 1996. "Investor valuation of the abandonment option," Journal of Financial Economics, Elsevier, vol. 42(2), pages 257-287, October.
    44. Heckman, James, 2013. "Sample selection bias as a specification error," Applied Econometrics, Publishing House "SINERGIA PRESS", pages 129-137.
    45. Vlieghe, Gertjan & Stephen Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed, 2003. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," Royal Economic Society Annual Conference 2003 212, Royal Economic Society.
    46. Manuel Arellano & Stephen Bond, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Oxford University Press, vol. 58(2), pages 277-297.
    47. Anil K Kashyap & Owen A. Lamont & Jeremy C. Stein, 1994. "Credit Conditions and the Cyclical Behavior of Inventories," The Quarterly Journal of Economics, Oxford University Press, pages 565-592.
    48. Albuquerque, R. & Hopenhayn, H.A., 1997. "Optimal Dynamic Lending Contracts with Imperfect Enforceability," RCER Working Papers 439, University of Rochester - Center for Economic Research (RCER).
    49. John Shea, 1997. "Instrument Relevance in Multivariate Linear Models: A Simple Measure," The Review of Economics and Statistics, MIT Press, pages 348-352.
    50. Sean Cleary, 1999. "The Relationship between Firm Investment and Financial Status," Journal of Finance, American Finance Association, vol. 54(2), pages 673-692, April.
    51. Richard Blundell & Stephen Bond, 1995. "Initial conditions and moment restrictions in dynamic panel data models," IFS Working Papers W95/17, Institute for Fiscal Studies.
    52. Robert E. Hall, 2004. "Measuring Factor Adjustment Costs," The Quarterly Journal of Economics, Oxford University Press, vol. 119(3), pages 899-927.
    53. Mark E. Doms & Timothy Dunne, 1998. "Capital Adjustment Patterns in Manufacturing Plants," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(2), pages 409-429, April.
    54. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, pages 1263-1285.
    55. Arellano, Manuel & Bover, Olympia, 1995. "Another look at the instrumental variable estimation of error-components models," Journal of Econometrics, Elsevier, pages 29-51.
    56. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, pages 115-143.
    57. Abel, Andrew B & Blanchard, Olivier J, 1986. "The Present Value of Profits and Cyclical Movements in Investment," Econometrica, Econometric Society, vol. 54(2), pages 249-273, March.
    58. Vlieghe, Gertjan & Stephen Bond & Alexander Klemm & Rain Newton-Smith & Murtaza Syed, 2003. "The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment," Royal Economic Society Annual Conference 2003 212, Royal Economic Society.
    59. Tullio Jappelli & Luigi Pistaferri, 2000. "The dynamics of household wealth accumulation in Italy," Fiscal Studies, Institute for Fiscal Studies, pages 269-295.
    60. Daniel S. Hamermesh & Gerard A. Pfann, 1996. "Adjustment Costs in Factor Demand," Journal of Economic Literature, American Economic Association, pages 1264-1292.
    61. Richard Blundell & Stephen Bond, 2000. "GMM Estimation with persistent panel data: an application to production functions," Econometric Reviews, Taylor & Francis Journals, pages 321-340.
    62. Stephen Bond & Dietmar Harhoff & John Van Reenen, 2010. "Investment, R&D and Financial Constraints in Britain and Germany," NBER Chapters,in: Contributions in Memory of Zvi Griliches, pages 433-460 National Bureau of Economic Research, Inc.
    63. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    64. Chirinko, Robert S. & Schaller, Huntley, 2009. "The irreversibility premium," Journal of Monetary Economics, Elsevier, pages 390-408.
    65. Russell W. Cooper & John C. Haltiwanger, 2006. "On the Nature of Capital Adjustment Costs," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 611-633.
    66. Windmeijer, Frank, 2005. "A finite sample correction for the variance of linear efficient two-step GMM estimators," Journal of Econometrics, Elsevier, pages 25-51.
    67. Chirinko, Robert S. & Schaller, Huntley, 2009. "The irreversibility premium," Journal of Monetary Economics, Elsevier, pages 390-408.
    68. Blundell, Richard & Bond, Stephen, 1998. "Initial conditions and moment restrictions in dynamic panel data models," Journal of Econometrics, Elsevier, pages 115-143.
    69. Daniel S. Hamermesh & Gerard A. Pfann, 1996. "Adjustment Costs in Factor Demand," Journal of Economic Literature, American Economic Association, pages 1264-1292.
    70. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, pages 1-54.
    71. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 169-215.
    72. Gelos, R. Gaston & Werner, Alejandro M., 2002. "Financial liberalization, credit constraints, and collateral: investment in the Mexican manufacturing sector," Journal of Development Economics, Elsevier, pages 1-27.
    73. Barton H. Hamilton, 2000. "Does Entrepreneurship Pay? An Empirical Analysis of the Returns to Self-Employment," Journal of Political Economy, University of Chicago Press, vol. 108(3), pages 604-631, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Caggese, Andrea, 2007. "Financing constraints, irreversibility, and investment dynamics," Journal of Monetary Economics, Elsevier, pages 2102-2130.
    2. Agustinus Prasetyantoko, 2006. "Financing Constraint and Firm Investment Following a Financial Crisis in Indonesia," Post-Print halshs-00133964, HAL.
    3. repec:gam:jsusta:v:8:y:2016:i:3:p:268:d:65781 is not listed on IDEAS
    4. Alessandra Guariglia & John Tsoukalas & Serafeim Tsoukas, "undated". "Investment, irreversibility, and financing constraints in transition economies," Discussion Papers 10/03, University of Nottingham, School of Economics.
    5. Bazdresch, Santiago, 2013. "The role of non-convex costs in firms' investment and financial dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 37(5), pages 929-950.
    6. Bayer, Christian, 2006. "Investment dynamics with fixed capital adjustment cost and capital market imperfections," Journal of Monetary Economics, Elsevier, pages 1909-1947.
    7. Guariglia, Alessandra & Tsoukalas, John & Tsoukas, Serafeim, 2012. "Investment, irreversibility, and financing constraints: Evidence from a panel of transition economies," Economics Letters, Elsevier, vol. 117(3), pages 582-584.
    8. Andrea Caggese, 2005. "Financing Imperfections and the Investments Decisions of Privately Owned Firms," Working Papers 265, Barcelona Graduate School of Economics.
    9. Christian Bayer, 2004. "On the Interaction of Financial Frictions and Fixed Capital Adjustment Costs: Evidence from a Panel of German Firms," Macroeconomics 0410006, EconWPA.
    10. Giuseppe Bonazzi & Mattia Iotti, 2016. "Evaluation of Investment in Renovation to Increase the Quality of Buildings: A Specific Discounted Cash Flow ( DCF ) Approach of Appraisal," Sustainability, MDPI, Open Access Journal, vol. 8(3), pages 1-17, March.
    11. Bellmann, Lutz & Gerner, Hans-Dieter & Hübler, Olaf, 2013. "Investment under Company-Level Pacts," IZA Discussion Papers 7195, Institute for the Study of Labor (IZA).
    12. Christian Bayer, 2001. "Aggregate investment dynamics when firms face fixed investment cost and capital market imperfections," Discussion Papers in Economics 01_13, University of Dortmund, Department of Economics.
    13. Becchetti, Leonardo & Castelli, Annalisa & Hasan, Iftekhar, 2008. "Investment-cash flow sensitivities, credit rationing and financing constraints," Research Discussion Papers 15/2008, Bank of Finland.
    14. Mattia Iotti & Giuseppe Bonazzi, 2016. "Assessment of Biogas Plant Firms by Application of Annual Accounts and Financial Data Analysis Approach," Energies, MDPI, Open Access Journal, vol. 9(9), pages 1-19, September.
    15. Guillaume Rocheteau & Pierre-Olivier Weill & Tsz-Nga Wong, 2015. "A Tractable Model of Monetary Exchange with Ex-post Heterogeneity," NBER Working Papers 21179, National Bureau of Economic Research, Inc.
    16. Santiago Carbó Valverde & Francisco Rodríguez-Fernández & Gregory F. Udell, 2008. "Bank lending, financing constraints and SME investment," Working Paper Series WP-08-04, Federal Reserve Bank of Chicago.
    17. Bayer, Christian, 2008. "On the interaction of financial frictions and fixed capital adjustment costs: Evidence from a panel of German firms," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3538-3559, November.
    18. Andrea Caggese & Vicente Cuñat, 2008. "Financing Constraints and Fixed-term Employment Contracts," Economic Journal, Royal Economic Society, vol. 118(533), pages 2013-2046, November.
    19. Chris Edson, 2012. "The capital constraining effects of the norwegian wealth tax," Discussion Papers 724, Statistics Norway, Research Department.

    More about this item

    Keywords

    Financing constraints; investments;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bge:wpaper:65. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Bruno Guallar). General contact details of provider: http://edirc.repec.org/data/bargses.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.