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Inventory investment and cash flow

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  • Ian Small

Abstract

This paper uses a panel of UK manufacturing firms to examine whether the effect of cash flow on inventory investment reflects the presence of financially constrained firms. Financially constrained firms are identified using a number of criteria, including the criterion suggested by Bond and Meghir (1994) based on the firm's financial policy. The main finding is that the effect of cash flow on inventory investment is concentrated among firms identified as financially constrained using either their financial policy or a criterion based on their current ratio. This suggests that there is no unique criterion for identifying financially constrained firms using financial information in company accounts. Contrary to what previous studies have found, using firm size or the coverage ratio to define financially constrained firms does not reduce the effect of cash flow on the inventory investment of unconstrained firms. This raises doubts about whether these are accurate indicators of whether a firm is financially constrained. Combined with Bond and Meghir's similar findings for fixed investment, the results in this paper suggest that cash flow effects form part of the monetary transmission mechanism.

Suggested Citation

  • Ian Small, 2000. "Inventory investment and cash flow," Bank of England working papers 112, Bank of England.
  • Handle: RePEc:boe:boeewp:112
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    File URL: http://www.bankofengland.co.uk/archive/Documents/historicpubs/workingpapers/2000/wp112.pdf
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    References listed on IDEAS

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    4. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    5. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    6. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-592, July.
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    Cited by:

    1. Paul Mizen & Cihan Yalcin, 2006. "Monetary Policy, Corporate Financial Composition and Real Activity," CESifo Economic Studies, CESifo, vol. 52(1), pages 177-213, March.
    2. Alberto Martin, 2004. "Endogenous credit cycles," Economics Working Papers 916, Department of Economics and Business, Universitat Pompeu Fabra, revised Aug 2008.

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