IDEAS home Printed from https://ideas.repec.org/p/qmw/qmwecw/862.html
   My bibliography  Save this paper

Sample separation and the sensitivity of investment to cash flow: Is the monotonicity condition empirically satisfied?

Author

Listed:
  • Alfonsina Iona

    (Queen Mary University of London)

  • Leone Leonida

    (King’s Business School, King’s College London)

Abstract

This paper studies whether the monotonicity condition of the investment-cash flow sensitivity is satisfied empirically. We show that if this condition holds, then the point of sample separation does not affect the monotonic relationship between the sensitivities of any two complementary classes of observations. Our test, based upon observable averages of the investment-cash flow sensitivity, rejects the monotonicity condition for any common metric of financing constraints we use. The testing procedure we propose reconciles the conflicting findings of the literature about the shape of the investment-cash flow sensitivity.

Suggested Citation

  • Alfonsina Iona & Leone Leonida, 2018. "Sample separation and the sensitivity of investment to cash flow: Is the monotonicity condition empirically satisfied?," Working Papers 862, Queen Mary University of London, School of Economics and Finance.
  • Handle: RePEc:qmw:qmwecw:862
    as

    Download full text from publisher

    File URL: https://www.qmul.ac.uk/sef/media/econ/research/workingpapers/2018/wp862.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Isil Erel & Yeejin Jang & Michael S. Weisbach, 2015. "Do Acquisitions Relieve Target Firms’ Financial Constraints?," Journal of Finance, American Finance Association, vol. 70(1), pages 289-328, February.
    2. Gilchrist, Simon & Himmelberg, Charles P., 1995. "Evidence on the role of cash flow for investment," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 541-572, December.
    3. 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.
    4. 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.
    5. Schiantarelli, Fabio, 1996. "Financial Constraints and Investment: Methodological Issues and International Evidence," Oxford Review of Economic Policy, Oxford University Press, vol. 12(2), pages 70-89, Summer.
    6. Sean Cleary, 1999. "The Relationship between Firm Investment and Financial Status," Journal of Finance, American Finance Association, vol. 54(2), pages 673-692, April.
    7. Heitor Almeida & Murillo Campello, 2007. "Financial Constraints, Asset Tangibility, and Corporate Investment," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1429-1460, 2007 12.
    8. Cleary, Sean & Povel, Paul & Raith, Michael, 2007. "The U-Shaped Investment Curve: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(1), pages 1-39, March.
    9. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 2000. "Investment-Cash Flow Sensitivities are Useful: A Comment on Kaplan and Zingales," The Quarterly Journal of Economics, Oxford University Press, vol. 115(2), pages 695-705.
    10. Nathalie Moyen, 2004. "Investment-Cash Flow Sensitivities: Constrained versus Unconstrained Firms," Journal of Finance, American Finance Association, vol. 59(5), pages 2061-2092, October.
    11. Stephen R. Bond & Måns Söderbom, 2013. "Conditional Investment–Cash Flow Sensitivities And Financing Constraints," Journal of the European Economic Association, European Economic Association, vol. 11(1), pages 112-136, February.
    12. Lyandres, Evgeny, 2007. "Costly external financing, investment timing, and investment-cash flow sensitivity," Journal of Corporate Finance, Elsevier, vol. 13(5), pages 959-980, December.
    13. Jason G. Cummins & Kevin A. Hassett & Stephen D. Oliner, 2006. "Investment Behavior, Observable Expectations, and Internal Funds," American Economic Review, American Economic Association, vol. 96(3), pages 796-810, June.
    14. Joan Farre-Mensa & Alexander Ljungqvist, 2016. "Do Measures of Financial Constraints Measure Financial Constraints?," Review of Financial Studies, Society for Financial Studies, vol. 29(2), pages 271-308.
    15. 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, vol. 19(1), pages 141-206.
    16. R. David Mclean & Mengxin Zhao, 2014. "The Business Cycle, Investor Sentiment, and Costly External Finance," Journal of Finance, American Finance Association, vol. 69(3), pages 1377-1409, June.
    17. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
    18. Huntley Schaller, 1993. "Asymmetric Information, Liquidity Constraints and Canadian Investment," Canadian Journal of Economics, Canadian Economics Association, vol. 26(3), pages 552-574, August.
    19. Gerard Hoberg & Vojislav Maksimovic, 2015. "Redefining Financial Constraints: A Text-Based Analysis," Review of Financial Studies, Society for Financial Studies, vol. 28(5), pages 1312-1352.
    20. Matthias M M Buehlmaier & Toni M Whited, 2018. "Are Financial Constraints Priced? Evidence from Textual Analysis," Review of Financial Studies, Society for Financial Studies, vol. 31(7), pages 2693-2728.
    21. 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.
    22. Allayannis, George & Mozumdar, Abon, 2004. "The impact of negative cash flow and influential observations on investment-cash flow sensitivity estimates," Journal of Banking & Finance, Elsevier, vol. 28(5), pages 901-930, May.
    23. Calomiris, Charles W & Hubbard, R Glenn, 1995. "Internal Finance and Investment: Evidence from the Undistributed Profits Tax of 1936-37," The Journal of Business, University of Chicago Press, vol. 68(4), pages 443-482, October.
    24. Ağca, Şenay & Mozumdar, Abon, 2017. "Investment–Cash Flow Sensitivity: Fact or Fiction?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 52(3), pages 1111-1141, June.
    25. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1991. "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups," The Quarterly Journal of Economics, Oxford University Press, vol. 106(1), pages 33-60.
    26. Lewellen, Jonathan & Lewellen, Katharina, 2016. "Investment and Cash Flow: New Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 51(4), pages 1135-1164, August.
    27. Erickson, Timothy & Whited, Toni M., 2002. "Two-Step Gmm Estimation Of The Errors-In-Variables Model Using High-Order Moments," Econometric Theory, Cambridge University Press, vol. 18(3), pages 776-799, June.
    28. Toni M. Whited & Guojun Wu, 2006. "Financial Constraints Risk," Review of Financial Studies, Society for Financial Studies, vol. 19(2), pages 531-559.
    29. Manuel Adelino & Katharina Lewellen & Anant Sundaram, 2015. "Investment Decisions of Nonprofit Firms: Evidence from Hospitals," Journal of Finance, American Finance Association, vol. 70(4), pages 1583-1628, August.
    30. Chen, Huafeng (Jason) & Chen, Shaojun (Jenny), 2012. "Investment-cash flow sensitivity cannot be a good measure of financial constraints: Evidence from the time series," Journal of Financial Economics, Elsevier, vol. 103(2), pages 393-410.
    31. Gayané Hovakimian, 2009. "Determinants of Investment Cash Flow Sensitivity," Financial Management, Financial Management Association International, vol. 38(1), pages 161-183, March.
    32. Charles J. Hadlock & Joshua R. Pierce, 2010. "New Evidence on Measuring Financial Constraints: Moving Beyond the KZ Index," Review of Financial Studies, Society for Financial Studies, vol. 23(5), pages 1909-1940.
    33. Armen Hovakimian & Gayané Hovakimian, 2009. "Cash Flow Sensitivity of Investment," European Financial Management, European Financial Management Association, vol. 15(1), pages 47-65, January.
    34. 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.
    35. 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.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Manzur Quader & Karl Taylor, 2018. "Corporate efficiency, credit status and investment," The European Journal of Finance, Taylor & Francis Journals, vol. 24(6), pages 439-457, April.
    2. Moshirian, Fariborz & Nanda, Vikram & Vadilyev, Alexander & Zhang, Bohui, 2017. "What drives investment–cash flow sensitivity around the World? An asset tangibility Perspective," Journal of Banking & Finance, Elsevier, vol. 77(C), pages 1-17.
    3. Nusrat Jahan, 2020. "Does Asset Durability Impede Financing? An Empirical Assessment," Carleton Economic Papers 20-17, Carleton University, Department of Economics, revised 07 Aug 2022.
    4. Álvarez, Roberto & Bertin, Mauricio Jara, 2016. "Banking competition and firm-level financial constraints in Latin America," Emerging Markets Review, Elsevier, vol. 28(C), pages 89-104.
    5. Mulier, Klaas & Schoors, Koen & Merlevede, Bruno, 2016. "Investment-cash flow sensitivity and financial constraints: Evidence from unquoted European SMEs," Journal of Banking & Finance, Elsevier, vol. 73(C), pages 182-197.
    6. Drobetz, Wolfgang & Haller, Rebekka & Meier, Iwan & Tarhan, Vefa, 2017. "The impact of liquidity crises on cash flow sensitivities," The Quarterly Review of Economics and Finance, Elsevier, vol. 66(C), pages 225-239.
    7. Jason G. Cummins & Kevin A. Hassett & Stephen D. Oliner, 2006. "Investment Behavior, Observable Expectations, and Internal Funds," American Economic Review, American Economic Association, vol. 96(3), pages 796-810, June.
    8. Firth, Michael & Malatesta, Paul H. & Xin, Qingquan & Xu, Liping, 2012. "Corporate investment, government control, and financing channels: Evidence from China's Listed Companies," Journal of Corporate Finance, Elsevier, vol. 18(3), pages 433-450.
    9. Schauer, Catharina & Elsas, Ralf & Breitkopf, Nikolas, 2019. "A new measure of financial constraints applicable to private and public firms," Journal of Banking & Finance, Elsevier, vol. 101(C), pages 270-295.
    10. Gaurav Gupta & Jitendra Mahakud, 2019. "Alternative measure of financial development and investment-cash flow sensitivity: evidence from an emerging economy," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 5(1), pages 1-28, December.
    11. Chen, Huafeng (Jason) & Chen, Shaojun (Jenny), 2012. "Investment-cash flow sensitivity cannot be a good measure of financial constraints: Evidence from the time series," Journal of Financial Economics, Elsevier, vol. 103(2), pages 393-410.
    12. Milos Markovic & Michael A. Stemmer, 2017. "Firm Growth Dynamics and Financial Constraints: Evidence from Serbian Firms," Documents de travail du Centre d'Economie de la Sorbonne 17012, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    13. Coad, Alex, 2010. "Neoclassical vs evolutionary theories of financial constraints: Critique and prospectus," Structural Change and Economic Dynamics, Elsevier, vol. 21(3), pages 206-218, August.
    14. Kwanglim Seo & Jungtae Soh & Amit Sharma, 2018. "Do financial constraints affect the sensitivity of investment to cash flow? New evidence from franchised restaurant firms," Tourism Economics, , vol. 24(6), pages 645-661, September.
    15. Najah Attig & Sean Cleary, 2014. "Organizational Capital and Investment-Cash Flow Sensitivity: The Effect of Management Quality Practices," Financial Management, Financial Management Association International, vol. 43(3), pages 473-504, September.
    16. Wang, Xun, 2022. "Financial liberalization and the investment-cash flow sensitivity," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    17. Ilker Yilmaz, 2022. "Leverage and Investment Cash Flow Sensitivity: Evidence from Muscat Securities Market in Oman," SAGE Open, , vol. 12(3), pages 21582440221, August.
    18. Rui Li & Kai Li & Hengjie Ai, 2017. "Moral Hazard and Investment-Cash-Flow Sensitivity," 2017 Meeting Papers 410, Society for Economic Dynamics.
    19. Sprenger, Carsten & Lazareva, Olga, 2022. "Corporate governance and investment-cash flow sensitivity: Evidence from Russian unlisted firms," Journal of Comparative Economics, Elsevier, vol. 50(1), pages 71-100.
    20. Bhagat, Sanjai & Moyen, Nathalie & Suh, Inchul, 2005. "Investment and internal funds of distressed firms," Journal of Corporate Finance, Elsevier, vol. 11(3), pages 449-472, June.

    More about this item

    Keywords

    Investment-cash flow sensitivity; Monotonicity condition; Sample separation;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:qmw:qmwecw:862. See general information about how to correct material in RePEc.

    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 bibliographic 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.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Nicholas Owen (email available below). General contact details of provider: https://edirc.repec.org/data/deqmwuk.html .

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

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.