Financial Constraints and Investment-Cash Flow Sensitivities: New Research Directions

  • Almeida H
  • Campello M
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Abstract

A key assumption in the existing theoretical work on Þrm Þnancial constraints is that these constraints translate entirely into higher costs of funds. This approach poses two types of difficulties to the research on that topic. First, it inadvertently narrows our understand- ing about Þnancial constraints since, in practice, Þrms often face credit rationing. Second, it is a matter of debate whether such an approach can deliver unambiguous implications for corporate investment. The current paper develops a theory explaining the relationship between corporate investment and cash ßow when Þrms face credit quantity constraints. We show that when Þrms’ investments and use of external Þnance are endogenously related, investment-cash ßow sensitivities increase as credit constraints are relaxed. From an empir- ical perspective, our analysis suggests a consistent way of identifying the impact of Þnancial constraints on corporate investment. Our predictions, however, are markedly different from those examined in most empirical studies in this area. ∗Heitor

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Authors

  • Heitor Almeida

  • Murillo Campello

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