Corporate investments and financing constraints: unraveling investment-cash flow sensitivities

Abstract

In the literature on financing constraints, recent studies estimate firm-varying investment-cash flow sensitivities (ICFS) to avoid methodological problems related to comparing sample-level estimates across groups. We go along with these advances and suggest two additional methodological improvements. First, we estimate firmvarying ICFS by modeling heterogeneous slopes in the investment equation, thereby taking into account the dynamics of the underlying investment model. Secondly, we study the drivers of ICFS in an ex-post regression thereby accounting for non-linear effects and ‘ceteris-paribus’-conditions. The results show that the ICFS is negatively related to size, dividend payout, profitability, and positively related to leverage suggesting a tight link between the ICFS and the firm’s constraints-status. Additionally, the ICFS is negatively related to the level and volatility of cash flow, suggesting that a significant ICFS occurs mainly in low cash flow-states and is lowered by the practice of cash-buffering when cash flows are volatile. Finally, we find evidence of a non-linear tangibility effect in line with the non-monotonic credit multiplier suggested in previous research.