Financing Constraints and Corporate Investment

Abstract

The article focuses on financing constraints and corporate investment. Empirical models of business investment rely generally on the assumption of a representative firm that responds to prices set in centralized securities markets. Indeed, if all firms have equal access to capital markets, firms' responses to changes in the cost of capital or tax-based investment incentives differ only because of differences in investment demand. A firm's financial structure is irrelevant to investment because external funds provide a perfect substitute for internal capital. In general, with perfect capital markets, a firm's investment decisions are independent of its financial condition. An alternative research agenda, however, has been based on the view that internal and external capital are not perfect substitutes. According to this view, investment may depend on financial factors, such as the availability of internal finance, access to new debt or equity finance, or the functioning of particular credit markets.