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How Sensitive Is Investment to Cash Flow When Financing Is Frictionless?

By Aydogan Alti N


I analyze the sensitivity of a ¢rm’s investment to its own cash £ow in the benchmarkcase where ¢nancing is frictionless. This sensitivity has been proposed as a measure of ¢nancing constraints in earlier studies. I ¢nd that the investment^cash £ow sensitivities that obtain in the frictionless benchmarkare very similar, both in magnitude and in patterns they exhibit, to those observed in the data. In particular, the sensitivity is higher for ¢rms with high growth rates and low dividend payout ratios. Tobin’s q is shown to be a more noisy measure of near-term investment plans for these ¢rms. DOES A HIGH SENSITIVITYof a ¢rm’s investment to its own cash £ow indicate that the ¢rm is ¢nancially constrained? A large body of research, starting with Fazzari, Hubbard, and Petersen (1988) (hereafter FHP), suggests that ¢rms facing ¢-nancing constraints should exhibit high investment^cash £ow sensitivities, re£ecting the wedge between the costs of external and internal funds. Empirical ¢ndings seem to give support to this hypothesis, since ¢rms classi¢ed as constraine

Year: 2011
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