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Further Evidence on the Relationship between Firm Investment and Financial Status

  • Robert Chirinko
  • Ulf von Kalckreuth

The interpretation of the significant relation between business investment spending and cash flow has been controversial. A large body of research has found that investment/cash flow sensitivities are higher for financially constrained firms. This fundamental result underlying the finance constraints hypothesis has been challenged recently by Kaplan, Zingales, and Cleary. The latter author introduces an important new element to this debate by using discriminant analysis, which allows creditworthy firms to be identified using an objective ex-ante criterion based on dividend payouts. Consistent with the Kaplan and Zingales critique, investment/cash flow sensitivities are lower for financially constrained firms. This short paper documents that the use of discriminant analysis does not necessarily lead to lower sensitivities. Our contrasting results are traceable to the use of the firm's creditworthiness as the discriminating variable and appropriate adjustments for endogenous regressors and serially correlated residuals. We document that the investment/cash flow sensitivity is higher for financially constrained firms.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0302.

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Date of creation: Jan 2003
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Handle: RePEc:emo:wp2003:0302
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  1. Franklin Allen & Antonio Bernardo & Ivo Welch, . "A Theory of Dividends Based on Tax Clienteles," Rodney L. White Center for Financial Research Working Papers 15-98, Wharton School Rodney L. White Center for Financial Research.
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  10. Steven N. Kaplan & Luigi Zingales, 2000. "Investment-Cash Flow Sensitivities are not Valid Measures of Financing Constraints," NBER Working Papers 7659, National Bureau of Economic Research, Inc.
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  13. Fabio Schiantarelli, 1995. "Financial constraints and investment: a critical review of methodological issues and international evidence," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 39, pages 177-226.
  14. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
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  16. Gustavo Grullon & Roni Michaely & Bhaskaran Swaminathan, 2002. "Are Dividend Changes a Sign of Firm Maturity?," The Journal of Business, University of Chicago Press, vol. 75(3), pages 387-424, July.
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