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Time to Build Capital: Revisiting Investment-Cashflow Sensitivities

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  • John Tsoukalas

Abstract

Is cash flow important in explaining investment dynamics? A large body of empirical work argues that it is. This finding is further taken as evidence of capital market imperfections. We argue 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. We demonstrate this using a perfect capital markets model with firms that make investment decisions in capital projects indexed by the length of the time-to-build. We show that the typical (empirical) investment regression with q and cash flow is ridden with specification error under time-to-build investment. This error is due to an omitted right hand side state variable (current expenditure on existing capital projects) that fully describes optimal investment along with marginal q and is strongly correlated with cash flow. 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.

Suggested Citation

  • John Tsoukalas, "undated". "Time to Build Capital: Revisiting Investment-Cashflow Sensitivities," Discussion Papers 09/05, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  • Handle: RePEc:not:notcfc:09/05
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    Cited by:

    1. Fabbri Giorgio & Federico Salvatore, 2014. "On the Infinite-Dimensional Representation of Stochastic Controlled Systems with Delayed Control in the Diffusion Term," Mathematical Economics Letters, De Gruyter, vol. 2(3-4), pages 1-11, November.
    2. Frédéric Zumer & Jacques Le Cacheux & Marc Flandreau, 1998. "Stability without a pact? Lessons from the European Gold Standard, 1880-1913," Sciences Po publications n°98-01, Sciences Po.
    3. Hansen, Erwin & Wagner, Rodrigo, 2017. "Stockpiling cash when it takes time to build: Exploring price differentials in a commodity boom," Journal of Banking & Finance, Elsevier, vol. 77(C), pages 197-212.
    4. Julian Emami Namini, 2009. "International Trade with Firm Heterogeneity in Factor Shares," Tinbergen Institute Discussion Papers 09-020/1, Tinbergen Institute.
    5. Bayraktar, Nihal, 2014. "Fixed investment/fundamental sensitivities under financial constraints," Journal of Economics and Business, Elsevier, vol. 75(C), pages 25-59.
    6. Emami Namini, Julian, 2014. "The short and long-run impact of globalization if firms differ in factor input ratios," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 37-64.

    More about this item

    Keywords

    Investment; Capital market imperfections; Time-to-build.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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