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Investment–Cash Flow Sensitivity: Fact or Fiction?
Abstract
We examine whether internal funds matter for investment when the measurement error in q is addressed. By carefully employing methodologies that tackle the measurement error in q , we show that cash flow is a significant determinant of investment. We also find that an analyst-forecast-based q measure is not superior to a stock-market-based q measure. We further propose an approach that uses two alternative proxies of q as instruments for addressing measurement error. Our evidence indicates that instrumental-variables-type generalized method of moments estimators yield empirically well-specified models.
... Indeed, the empirical evidence documents a positive impact of financial development on economic growth and gross capital formation (Beck et al. 2014;Cama and Emara 2022;Hunjra et al. 2022;Nguyen 2022;Popov 2018). In addition, firm-level based evidence shows that firms facing credit constraints, i.e., when external finance provided by the financial sector is costly or unavailable, are forced to rely on their internal sources of finance, causing a larger degree of sensitivity of investment to cash flow (Agca and Mozumdar 2017;Chiu et al. 2022;Ek and Wu 2018;Fazzari et al. 1988Fazzari et al. , 2000Lewellen and Lewellen 2016;Tayem 2015b). The present article builds on this literature by examining the impact of declining economic conditions on the sensitivity of investment to cash flow using the context of Jordan, a developing market from the Middle East and North Africa (MENA) region, with a focus on the role of a firm's reliance on bank debt on attenuating (or exacerbating) the impact of these conditions on investment-cash flow sensitivity. ...
... The literature on investment-cash flow sensitivity focuses mainly on firm-specific factors that influence the investment-cash flow relationship (Agca and Mozumdar 2017;Chiu et al. 2022;Ek and Wu 2018;Fazzari et al. 1988; Lewellen and Lewellen 2016;Tayem 2015b), with little research on the impact of macro conditions on this relationship. Although there is important literature on the relationship between macro conditions and firms' investments, the focus of this literature is on the impact of those conditions on firm investment behaviour, not on investment-cash flow sensitivity. ...
... How do these conditions affect the investment-cash flow sensitivity of firms reliant on bank debt? To answer these questions, the study utilizes the standard Q theory of investment (Hayashi 1982;Tobin 1969), augmented with cash flow to capture investment sensitivity to the availability of internal finance (Agca and Mozumdar 2017;Chiu et al. 2022;Ek and Wu 2018;Fazzari et al. 1988;Lewellen and Lewellen 2016;Tayem 2015b). This study follows the literature by subdividing listed Jordanian firms into two clusters based on their access to lines of credit, a measure of a firm's reliance on bank debt. ...
This paper examines the sensitivity of investment to cash flow in declining economic conditions, focusing on the impact of a firm’s reliance on bank debt. Using the context of Jordan, a developing Middle East and North Africa (MENA) country, the study utilizes the standard Q theory of investment augmented by cash flow, leverage, and liquidity. Then, it allows for differential loading on the cash flow coefficient pre- and post-2008, the year that marks the beginning of declining conditions, and by categorizing companies based on their reliance on bank debt, measured by having access to a bank line of credit. Using alternative estimation specifications, the findings indicate that firms’ investments decreased significantly in episodes of declining conditions. In addition, the findings indicate that firms’ investments exhibited more sensitivity to cash flow during declining conditions, especially for firms with access to lines of credit. The latter finding suggests that firms reliant on bank debt could not compensate for the credit shortages by switching to other sources of external funding and therefore they were compelled to use more of their internally generated funds to finance their investments.
... This paper fits into two strands of literature in corporate finance and economics. First, it is related to studies which attempt to examine the cross-sectional and time-series patterns of cash flow sensitivity (Agca and Mozumdar, 2017;Chen and Chen, 2012;Hadlock and Pierce, 2010, among many others). This paper, however, provides an alternative perspective by examining the pattern of covariance between cash flow and q. ...
... The EW (2000) measurement-error-corrected estimates, which 1 EW (2000,2002) have suggested applying the high-order moment-based GMM estimator (EW estimator) to purge the measurement error. Almeida et al. (2010) maintain that EW estimator performs badly in case of heterogeneity and low skewness of data and recommend using instrumental variables-type estimator (see also Agca and Mozumdar, 2017). EW (2012), in response, argue that the poor performance is due to the misuse of starting values and EW estimator outperforms IV estimator when measurement error is serially correlated. ...
... The examples of contributions that study investment-cash flow sensitivity via the channel of measurement error areErickson and Whited (2000, 2002;Gomes (2001);Alti (2003);Cooper and Ejarque (2003);Cummins, Hassett and Oliner (2006);Almeida, Campello and Galvao (2010);Agca and Mozumdar (2017), and among others ...
The effect of measurement error, which operates via the covariance between q and cash flow, plays an important part in explaining the time-series and cross-section of cash flow sensitivity. We find that the measurement error decreases investment-cash flow sensitivity in the recent decades because it biases cash flow sensitivity downward when q and cash flow are negatively covaried. The covariance structure also offers explanations for the perceived "wrong-way" differential investment-cash flow sensitivity between constrained and unconstrained firms (the perceived negative relationship between investment-cash flow sensitivity and constraints status) classified under the widely used a priori measures. Moreover, we show that even the higher-order moment-based GMM estimator cannot address the bias if the measurement error is not independent of q (a nonclassical error).
... The solutions usually involve including varied factors, which distort the regressions' associated results (and the underlying ASI, as we shall see in subsequent sections). Among the works with contradictory results, we have Guariglia (2008); Carpenter and Guariglia (2008); Chen et al. (2016); Lewellen and Lewellen (2016); Ağca and Mozumdar (2017);and Kashefi-Pour et al. (2020), who found increasing investment-cash flow sensitivity, whereas others Chen 2012 andMoshirian et al. 2017) confirmed a decreasing linkage. This has led some authors to express their skepticism. ...
This study employs a Monte Carlo simulation to see whether accounting identity problems are present in the Fazzari, Hubbard, and Petersen model (1988). The Monte Carlo simulation generates 50,000 random cash flows, Tobin’s Q, and error term variables, which shape an investment variable that is dependent on them. Cash flows and investments are linked by a partial accounting identity, also known as an accounting semi-identity (ASI). An accounting identity is, for example, an equality between the left and right sides of a balance sheet. An ASI is not a complete one since one or more components of the accounting identity are missing. The estimated coefficients of an ASI do not represent reality, according to the OLS estimations. The regression tells us less about causality the closer the data are to the accounting identity. This is the first time that the biases of OLS estimations in an ASI-based model have been demonstrated.
... Because the market mechanism of Chinese stock market is not perfect enough to reflect all the information in the market, and its effectiveness is weak, there are relatively many stocks that are wrongly priced, and the purpose of studying quantitative investment is to capture as many investment opportunities as possible in the capital market. Therefore, quantitative investment research in China's capital market is profitable [14]. At the same time, because China's stock market often has problems such as disorderly rise and fall and strong randomness, combining quantitative stock selection model with quantitative timing strategy can effectively control some factors of human intervention in every link from selecting individual stocks to optimizing position control, from judging the risk of portfolio to executing trading, which can not only reduce investment risks and obtain relatively stable investment returns but also promote the stable, healthy, and sustainable development of the stock market [15]. ...
The security information database has accumulated a large amount of historical data due to the continuing development of the securities market. People are concerned about how to fully utilize these data to investigate the securities market’s law. In the financial field, financial asset pricing is a major issue. To some extent, the size of the return is determined by the difference between asset prices and their intrinsic value. The total global investment scale of quantitative funds will surpass 20 billion yuan by the end of 2021. Global asset management firms have turned to quantitative funds as their most important investment tool. Quantitative investment applies a specific investment idea to a specific model by creating specific indicators and parameters and then executes the investment strategy, greatly increasing the breadth and depth of investment. The goal of investors is to understand risk and maximize returns on investment. Researchers and investors alike value quantitative investment because of its scientific and efficient operation. In quantitative stock selection, a multifactor stock selection model is a critical tool for building a portfolio. This paper builds a multifactor investment strategy based on the relevant factors of corporate finance and valuation, selects the portfolio, and calculates the excess return using a machine learning classification algorithm.
... In other words, the broader research gap addressed by this paper is the relationship between TD practices, financing constraints, and investment behaviour in an emerging economy context where very particular ownership patterns prevail. The study builds on literature dealing with financing constraints on fixed investment and particularly those studies that introduce the corporate governance framework into investment-cash flow relationship (Ağca/Mozumdar 2017;Brown/Petersen 2009;Fazzari et al. 1988Fazzari et al. , 2000Francis et al. 2013;Guariglia/Yang 2016;Kaplan/Zingales 1997Hadlock/Pierce 2010;Hubbard 1998;Moyen 2004;Lu/Wang 2015;Mulier et al. 2016, Raith et al. 2007). To my knowledge, there is no peer-reviewed empirical research on the effects of governance on investment behaviour in Russia except for Perotti and Gelfer (2001) which is based on a much earlier economic period, and Grosman and Leiponen (2018) which does not explicitly test the effect of ownership in relation to TD and investment. ...
This study examines the impact of transparency and disclosure scores on fixed investment utilizing the unique features of the Russian capital market. I find that transparency has a positive and significant impact on fixed investment. However, state-owned enterprises are more sensitive than oligarch-owned enterprises to improved transparency. I find robust evidence that greater transparency of financially constrained firms positively affects investment. Transparency, therefore, is a valid mechanism for reducing financing constraints on investment.
... Guariglia (2008) also argues that q model only forecasts outsiders' assessments of investment opportunities and does not assess insiders' estimation of opportunities. Though, some recent studies have been trying to tackle the measurement error in q (such as Agca & Mozumdar, 2017). ...
Using Q investment model to scrutinize investment-cash flow sensitivity, a measure of financial constraint, has been a subject of controversy in literature. By using an alternative model called Error Correction model, this study aims to check the sensitivity between firm’s internal finance and investment level for the case of lower middle income country. Literature has shown that firms’ specific characteristics affect the relation between investment and cash flow of the firms. By considering the unique characteristics of Pakistani corporate sector, this study further target to check whether the investment-cash flow sensitivity differs across size of the firms, group affiliation of the firms and dividend policy of the firms. Our findings indicate that Pakistani listed firms are financially constrained. We find a strong relationship between investment and cash flow for small and non-dividend-paying firms; whereas group-affiliation does not affect investment- cash flow sensitivity of firms.
... These results are consistent with research showing that restatements involving core accounts are more serious than those involving non-core accounts (Beatty et al., 2013;Nguyen & Puri, 2014; and that negative information is more readily processed and more credible than positive information (Kuhnen, 2015;Larcker & Zakolyukina, 2012). Finally, regarding financing mechanisms, the association between changes in rivals' investments and restatement tone is stronger when rivals have a lower cost of capital and more cash, consistent with research showing that firms invest more when they have a lower cost of external financing and more cash (Agca & Mozumdar, 2017;Beatty et al., 2013;Frank & Shen, 2016). ...
... Firms with a high ratio of tangible assets may involve in investment related to productivity. Moreover, some studies [38,39] argue that firms tend to invest in tangible assets to relax financial constraints and shift over time from tangible assets to investment in intangible and liquid assets. Thus, there is potential influence for tangible assets on the investment decision in form takeovers. ...
This paper empirically examines firm-characteristics determinants of mergers and acquisitions (M&A) likelihood by Malaysian public listed firms. This study specifically investigates the impact of firm characteristics on acquisition likelihood using 9998 firm-year observations during the period from 2001 to 2018. Past studies regarding Malaysian
M&As mostly focus on the performance of M&As and its determinants. Using Probit regression, findings suggest that firms’ size, sales growth, and stock return positively affect firm probability to involve in M&As. while, leverage, profitability, cash holding, and tangibility affect M&A likelihood negatively. The findings also suggest that firms’ characteristics in the current M&A year can explain M&A decision better than they do in the pre-M&A year. Our findings provide insights to managers, investors, and regulators in order to understand more about corporate takeovers which is an important growth and survival strategy for businesses.
Keywords: M&A likelihood, firm characteristics, probit regression, Malaysian takeover.
... However, if one expects the residuals from the regression of I on Q being correlated with changes in cash flow, such correlation would reject the frictionless Q model, while suggesting an alternative investment model in which financing constraints play a role. This is the main reason why a very large literature has proliferated on the investment-cash flow sensitivity [23][24][25][26][27][28][29][30][31][32]. This research has pointed out that, in presence of financing frictions, investment decisions depend not only on Q but also on the availability of internal finance and cost of external finance. ...
This paper provides a theoretical framework for studying the impact of self-interested managers on the level of corporate investment. I extend the standard neoclassical model of firm value maximization to incorporate the effect of misaligned managers on corporate investment via a firm’s profit, adjustment costs of capital and shadow cost of external finance. Under some assumptions, commonly made by the relevant literature, the model shows that the intensity of agency conflicts between misaligned managers and outside shareholders affects a firm’s investment decisions generating either under or overinvestment with respect to a perfect capital market and driving a higher cost of external finance.
... To conduct the econometric tests, we used dynamic panel-data models with the generalized method of moments (GMM) estimation, as proposed by Arellano and Bond (1991). According to Agca and Mozumdar (2017), this type of estimator tends to be well specified to test the sensitivity of the relationships between investments, Q ratio, and cash flow. They are also robust estimators even when the econometric models present problems of endogeneity. ...
This paper examines whether the capital market and the internal generation of cash flows bring relevant information to decisions on corporate investments. For this investigation, we used data from 255 companies located in four Latin American (LA) countries: Brazil, Chile, Mexico and Peru (BCMP countries). The analysis period is from 2000 to 2017. The results indicate that cash flow represents one of the main drivers of corporate investments. In contrast, there were no indications that the capital market translates into a mechanism for transmitting useful information to firm managers about investments. Other drivers of value identified are associated with sales, cash and cash equivalents, and asset tangibility.
... Previous studies have cited many factors that affect a firm's investment opportunities. Ağca and Mozumdar (2017) find that internal funds and cash flows are important and significant determinants of firm investment. Bialowolski and Weziak-Bialowolska (2014) conduct a study on Polish companies and found that payment delays and legal and macroeconomic factors considerably affect firm investment decisions. ...
The main objectives of this study are to examine the impact of stock price performance on firm’s investment and to investigate the counter impact of changes in investment expenditures on stock price performance. The random effects model was applied on the panel data of Chinese manufacturing firms listed at the Shanghai Stock Exchange and the Shenzhen Stock Exchange during the period 2002 to 2016. The sample contains 398 firms with 5,970 observations. Although there is a statistically significant and negative relationship between stock price and investment expenditures, the impact of stock price on investment expenditures is far greater than that of investment expenditures on stock price. Information asymmetry positively mediates both investment sensitivity to stock prices and stock prices sensitivity to investment. This study is a valuable contribution toward the analysis of investment decision making by manufacturing firms in China. It also provides guidelines for investors to assess the informational status of the capital market before making investment decisions and to comprehensively understand the different decisions made by firms with regard to the issue of new stocks and the indirect information attached with such issues.
... Cleary (1999) corroborates Kaplan and Zingales (1997) while Gomes (2001) points to the lack of theoretical foundations for a positive linkage between investment and cash flows. However, using different firm-level proxies for asymmetric information (such as size, age, ownership structure, capital intensity, commercial papers, and bond ratings), several studies have confirmed that investment is related to cash flows (Aǧca and Mozumdar 2017;Hoshi, Kashyap, and Scharfstein 1991;Kadapakkam, Kumar, and Riddick 1998). ...
We investigate the effect of pyramidal ownership and family control on the investment-cash flow sensitivity of Brazilian firms using financial constraint indexes to classify firms. For constrained firms, we find that family control does not directly influence the investment-cash flow sensitivity, while for unconstrained firms, family control has a negative effect on investment decisions. However, the active involvement of the controlling family on the board increases the investment-cash flow of unconstrained firms, possibly aggravating agency problems. Regarding pyramidal ownership, we provide evidence that is consistent with the idea of the internal transfer of funds among firms that possess the arrangement structure.
... Muitos estudiosos abordaram o papel desempenhado pela liquidez de reservas, fluxos de caixa e gerenciamento da estrutura de capital na moderação dos efeitos das restrições financeiras sobre investimentos empresariais. Incapazes de obter financiamento externo, as empresas mostram sensibilidade ao investimento no fluxo de caixa, uma vez que surge uma relação positiva entre o fluxo de caixa de uma empresa e as despesas de capital (Ağca & Mozumdar, 2017;Fazzari, Hubbard, & Petersen, 1988;Stein, 2003). ...
This study assesses whether the trade-off or the pecking order theories explain the increased cash ratios in Latin American firms. It also assesses the explanatory power of additional variables that identify key macroeconomic features in Latin American economies. Due to its noticeable increase, cash became a key feature of Latin American firm performance over the last decades. The need for a better understanding is stressed by the fact that, during most of the last decade, these firms experienced a phase of accelerated economic growth and buoyant financial markets. The resulting surge in real investment opportunities within this period makes the growing cash holdings all the more puzzling. As far as we know, no other research addresses this issue in a direct way. There are robust facts about the increased cash holdings in Latin American firms. This article assesses traditional explanations and defines which fits more properly to the study sample. A complementary explanation regarding exchange rate exposure and key macroeconomic variables is constructed and empirically evaluated. To address potential sources of endogeneity, dynamic panel data methods are used. Particularly, the system generalized method of moments (GMM) was applied, as proposed by Blundell and Bond (1998). This article reports an increasing trend for corporate cash holdings in a sample of selected Latin American firms between 2000 and 2014. Likewise, net leverage and short-term debt show a declining trend over the same period. The trade-off theory may explain this. A substantial effect of macroeconomic variables particularly affecting firms that operate in the region is observed, such as exchange rate risks.
... The solutions usually involve including varied factors, which distort the regressions' associated results (and the underlying ASI, as we shall see in subsequent sections). Among the works with contradictory results, we have Guariglia (2008); Carpenter and Guariglia (2008); Chen et al. (2016); Lewellen and Lewellen (2016); Ağca and Mozumdar (2017);and Kashefi-Pour et al. (2020), who found increasing investment-cash flow sensitivity, whereas others Chen 2012 andMoshirian et al. 2017) confirmed a decreasing linkage. This has led some authors to express their skepticism. ...
Researches will not draw the correct inferences about the values of coefficients estimated in a linear regression when both the dependent and the independent variable are part of an accounting identity (or accounting semi-identity close to a full one). The coefficients cannot tell us about a causal relation as the two variables will change together to satisfy the identity. A good example of a model that suffers from this problem is the Fazzari, Hubbard and Petersen (1988) investment-cash flow sensitivity model. The econometric problems in estimating accounting identities are not new, and have been highlighted in the debate about the Cobb-Douglas production function estimation. The causal influence on the dependent variable when variables do not form part of the accounting semi-identity can be estimated correctly if the independent variable in the accounting semi-identity leaves a large part of the dependent variable unexplained. A feasible way to solve the problem is to disaggregate the identity by replacing either the dependent or the independent variable by an appropriate substitute that is not part of the identity.
Nghiên cứu kiểm định sự nhạy cảm của đầu tư theo dòng tiền tại các nền kinh tế mới nổi. Mẫu nghiên cứu gồm các doanh nghiệp thuộc 13 nền kinh tế mới nổi trong giai đoạn 2000-2020. Sau khi kiểm soát sai số đo lường trong q – biến đại diện cho cơ hội đầu tư, nghiên cứu cho thấy đầu tư của doanh nghiệp tại các quốc gia mới nổi phụ thuộc đáng kể vào dòng tiền của doanh nghiệp. Bên cạnh đó, các doanh nghiệp bị hạn chế tài chính có sự nhạy cảm của đầu tư theo dòng tiền cao hơn các doanh nghiệp không bị hạn chế tài chính. Các kết quả này hàm ý rằng, sự phụ thuộc của đầu tư theo dòng tiền là minh chứng về giới hạn tài trợ do các bất hoàn hảo tài chính.
In this study, we examine whether investments in fixed (identifiable) intangible assets and tangible assets are sensitive to cash flow and the extent to which this sensitivity differs for firms with different levels of financial constraints. Using both UK private and public firms' data, our overall analysis shows strong positive (negative) effects of cash flow on intangible assets (tangible assets) investments. When we split the data on the basis of listing status, we observe that cash flow is positively (negatively) and significantly related to intangible assets (tangible assets) investments for private firms but not so for public firms. In addition, we further observe that both public and private firms' investments follow a similar pattern when we split our data based on the availability of internal funds. Moreover, we also find that the sensitivity of investment (identifiable intangible assets) to cash flow is higher for young and large private firms but lower for small and old ones. Our results remain similar to other econometric specifications, which account for possible endogeneity issues.
We find that the volatility of institutional ownership affects the investment behavior of real estate investment trust (REIT) managers. REITs exhibit stronger growth in real estate assets when they experience more volatility in institutional ownership. Debt is the likely source of financing these investments, whereas institutional ownership volatility does not explain for the equity issuance decisions of REITs. The effect of ownership dynamics on the investment decisions of REITs is mostly driven by institutions that hold highly diversified portfolios, which are classified as quasi-indexers and transient investors. The contribution of ownership volatility emerging from individual trading decisions of institutional stakeholders matters more than the ownership volatility of the institutional sector as a whole. Our findings suggest that REITs may cater their portfolios to the preferences of certain institutional investors.
We examine how regulatory nudges mandating only disclosure of ownership information and no structural change impact a firm’s access to capital based on its organizational form. As a first of its kind, Clause 35 in India (characterized by weak enforcement and concentrated ownership) only required classifying shareholders into insiders and outsiders. Pre-regulation, group-affiliated firms exhibited lesser financial constraints than standalone firms. This reverses post-regulation, especially for group firms with higher insider ownership. More so for those with weaker compensating mechanisms or poorer future performance. In essence, regulation exclusively requiring information disclosure has been effective in reallocating capital more efficiently to firms with fewer agency problems.
Our paper examines whether dividends convey information about future cash-flow volatility in the Chinese stock markets. We observe that dividend changes are followed by cash-flow-volatility changes in the opposite direction. Taking advantage of the unique context of China, we show, in both the two-way sorting analysis and the regression analysis, that the strong relation between changes in dividend and cash-flow volatility is robust after controlling for potential confounders, including firm-level financial market frictions, macroeconomic and market conditions, and government intervention in firms' decision-making, and holds after we control for endogeneity concerns. Furthermore, we perform the theoretic mechanism tests of the relation and present supporting evidence on the signaling theory under the setting of asymmetric information, instead of the free cash flow theory based on the assumption of agency conflict. This study enriches our understanding of the source and nature of cash-flow information contained in dividends.
The decline and diminishment of investment-cash flow sensitivity remains a puzzle in literature. This paper attempts to address this puzzle by examining the heterogeneous effects of domestic financial liberalization and international financial integration on corporate investment-cash flow sensitivity. Using a large firm level data for 69 developed and emerging economies over the period 1995-2019, we provide robust evidence that firms in countries with more liberalized domestic financial markets exhibit lower sensitivity of investment to the availability of cash flows. Reducing financial constraints and then promoting external finance are possible mechanisms through which domestic financial liberalization affects investment-cash flow sensitivity. While the effect of international financial integration, on average, is less clear, our results show that increases in international financial integration promote investment more for firms with higher cash flows in high income economics but more for firms with lower cash flows in non-high income economies. Our paper provides new insights into the real effects of financial institutional arrangements on the economy.
The management policy for Taiwan's corporate social responsibility (CSR) reporting was changed from elective to partial mandatory. Some companies that have already submitted their reports are also required to undergo assurance provided by accountants. The present study explores the influences of Taiwan's partial mandatory disclosure and partial mandatory assurance management policies for CSR reports on firms' investment to cash flow sensitivity which is used to measure the information transparency of the capital market. The results showed that investment to cash flow sensitivity decreased after mandatory disclosure and mandatory assurance. This implies that the partial mandatory disclosure and the partial mandatory assurance policies for CSR reports have a positive influence on mitigating information asymmetry and agency problems being experienced by firms. It also indicates that Taiwan’s partial mandatory disclosure and partial mandatory assurance policies for CSR reports aid in increasing information transparency of its capital market.
This paper investigates how corporate governance of unlisted firms in an emerging market economy affects financing constraints, measured by the sensitivity of investment to cash flow. In order to evaluate the quality of corporate governance, we develop two corporate governance indices based on a large-scale survey of Russian enterprises – one for shareholder protection and one for transparency. We estimate standard investment regressions where the cash flow variable is interacted with our corporate governance indices and variables capturing the ownership structure. The central result is that better shareholder protection diminishes the cash flow sensitivity of investment, particularly in firms with an outside controlling owner. In contrast, we do not find such an effect for transparency, which can be partially explained by the threat of hostile takeovers. We address the problem of the endogeneity of corporate governance by using fixed-effects regressions and a novel instrumental variable based on particular legal provisions for corporate governance in Russia depending on the number of shareholders.
We demonstrate that the severity of financial constraints has declined over time for two reasons: (i) improved access to external funds as evidenced by a decreased reliance on internal cash flows, and (ii) an inward shifting investment frontier with reduced investment opportunities. The decline in financial constraints coincides with the documented diminishing sensitivity of investment to cash flows, yet we show that cash flows remain a determining factor in helping constrained firms overcome restricted access to external capital. There is a flight‐to‐quality during economic shocks, where the adverse effects following periods of tightened credit are particularly pronounced for smaller firms, with larger firms appearing largely unaffected.
This article is protected by copyright. All rights reserved.
It is well documented that since at least the 1970s investment-cash flow (I-CF) sensitivity has been decreasing over time to disappear almost completely by the late 2000s. Based on a neoclassical investment model with costly external financing, we show that this pattern can be explained by the gradual increase of capital adjustment costs, attributable to the accumulation of knowledge capital. The result is robust to a variety of approaches, including Euler equation estimation and the simulated method of moments. More generally, our findings demonstrate that I-CF sensitivity should only be interpreted as a joint measure of financial and real frictions.
Purpose
This paper examines the contentious relationship between investment and cash flow using the 2008–2009 credit supply shock as a form of the quasi-natural experiment.
Design/methodology/approach
Panel threshold models with unknown sample separation are estimated for a sample of publicly listed firms from nine African countries over the period 2003–2012. Using this approach reduces subjective or ex ante sample-splitting bias that is not accounted for in the extant literature.
Findings
The findings of the study indicate that investment–cash flow sensitivity is decreasing even during the global financial crisis (GFC) and for firms more likely to be financially constrained. The authors conclude that the usefulness of investment–cash flow sensitivity as a proxy for financial constraints is diminishing over time, even after directly addressing biases from ex ante subjective sample splitting and various forms of endogeneity.
Originality/value
The authors provide new empirical evidence from sharper tests of financial constraints for understudied African firms and highlight the need to relook at the usefulness of investment–cash flow sensitivity as a proxy of financial constraints.
Investment decision making is a crucial process influenced by many factors, such as cash flow. Therefore, it is important for potential investors to understand the stability of cash flow. This study aims to examine cash flow and investment-cash flow sensitivity on investment in manufacturing companies listed in Indonesia Stock Exchange from 2011 to 2015. A panel data methodology by a fixed-effect model with cross-section weights, standard errors, and covariance were utilized. It comprises two models, Panel A and B, with each consisting of all samples, and financially constrained grouping by Kaplan and Zingales-index (KZ-index). The finding that investment-cash flow sensitivity and financially constrained had a significant positive on investment. The result suggests it is important for investment decisions. In panel B, Tobin’s Q was significantly applied to unconstrained companies to prevent a negative impact on sales, with the application of the closing price. The managerial implication of this research is addressed to company managers, potential investors, and readers. In conclusion, cash flow, long-term debt, working capital investment, leverage, and asset turnover impacts on investment for all estimations.
According to a recent conjecture in the literature, earnings have become a poorer proxy for cash flow from operations over time. We find that since 1988, when cash flow statements started to be consistently reported in Compustat, the cash effectiveness of earnings has actually increased for a large sample of U.S. manufacturing firms. This occurs despite the introduction of fair value accounting and increasing accounting accruals during the last three decades. Also contrary to the conjecture, using more comprehensive measures of cash flow does not restore the investment‐cash flow sensitivity, which continues to be around 0.05 in more recent periods. This article is protected by copyright. All rights reserved
The main objective of this paper is to propose a loan approval evaluation framework of public-private partnership project (PPP) of battery storage power station (BSPS) for the commercial bank to evaluate and select the optimal project to provide the loan and then promote the development of BSPS-PPP. In order to achieve this goal, this study proposed a loan approval evaluation index system which consist of 5 attributes, 14 criteria and 45 sub-criteria. The novelty of this loan evaluation index system is that it reflects the basic requirement of loan approval of the commercial bank based on the characteristics of BSPS and PPP project, the commercial banks can better prepare for possible risks of BSPS-PPP. The proposed decision model was established based on the interval-valued intuitionistic fuzzy value (IVIFV) and interval number. Its novelty is that ①The model not only satisfies the experts’ expression habit of uncertainty, but also can be handled the uncertainty in the performance evaluation value and the criteria’s weights properly; ②the proposed weight determining method based on the deviation maximization principle can not only maintain the will of decision makers as much as possible, but also decrease the uncertainty of weights. Finally, the effectiveness of loan approval evaluation framework was verified based on a case study of China. According to the application effect of the evaluation index system and the proposed model, 3 managerial implication are put forward.
We investigate the influence of national culture on corporate investment–cash flow sensitivity. We conjecture that national culture shapes managerial perceptions of information asymmetry and agency problems, thus impacting the investment–cash flow relationship. We document empirical evidence in support of our claim. By linking the investment–cash flow sensitivity to cultural differences, our findings show that, while collectivism has an attenuating influence, uncertainty avoidance, power distance and masculinity have a reinforcing effect on the relationship between cash flow and investment. Our results hold for a sample of 205,268 firm‐years across 24 OECD countries between 1990 and 2017, and are robust after accounting for alternative statistical approaches, sample compositions and measures of cultural dimensions, along with controls for institutional and governmental factors. In addition, by decomposing cash flow into uses and sources of funds in a dynamic multi‐equation model, where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash, we find that national culture shapes how firms react to changes in cash flow.
Purpose
On the basis of principal-agent and financing constraints theories, the purpose of this paper is to construct a unified research framework via mathematical models and to provide a logical and consistent explanation of the contradictory discovery of the relationship between dividend payment and I-CFO in the previous literature.
Design/methodology/approach
Establishing the economic mathematical models, this paper uses the comparative static analysis to figure out the equilibrium results, to further testify the conclusions, the authors initiate the empirical tests to make the discussion more realistic.
Findings
The authors observe that overinvestment caused by agency problems is the primary reason for I-C sensitivity when the investment expenditure is less than the internal capital; dividend payout suppresses the overinvestment caused by the agency problem, thus alleviating the investment’s dependence on the internal capital. However, underinvestment caused by the financing constraints is the primary cause of I-C sensitivity when the investment expenditure is greater than the internal capital. The payment of cash dividends increases the investment shortage caused by the financing constraints, thus increasing the sensitivity. Further, the authors explore the impact of dividend payments on I-CFO sensitivity. They argue that dividend payment is not an appropriate measure of financing constraints. Both I-CFO sensitivity and I-C sensitivity are functions of agency cost and information cost.
Research limitations/implications
This study provides a logical and consistent explanation of the contradictory discovery of the relationship between dividend payment and I-CFO in the previous literature and provides a clear framework and reference for future studies on the impact of financial constraints, agency cost on the investment’s dependence on the internal capital.
Practical implications
The theoretical model of this paper supports this differentiated mandatory dividend policy and provides reference and evidence for China's financing policies and dividend distribution policies.
Originality/value
This study theoretically and empirically analyzes and verifies the roles of agency cost and financial constraints on the determinants of I-C sensitivity for the first time. First, different from earlier literature, this paper puts forward I-C sensitivity as a new measure of investment’s dependence on internal capital, making the measurement more accurate. In the case of a firm with positive liquidity reserves, using the I-CFO sensitivity as a measure of external financing constraints could overestimate the firm’s financial constraints. Second, by constructing an economic static analysis framework, this study analyzes how I-C and I-CFO sensitivities change with the agency cost, the financing constraints and the dividend payment ratio. The research provides a basic framework and explanation on the contradictions of the earlier literature. The results are supposed to serve as a foundation for estimations of investment’s dependence on internal capital and should be embedded in general empirical tests in future research.
Using investment–cash flow sensitivity to analyze financial constraints over the period 2006–2011 in the Czech Republic, we find that healthy companies were financially constrained both before and after the 2008 crisis. There is robust evidence that both the cash flow and the level of debt have a positive and significant impact on the investment rate. Although companies going bankrupt had significantly higher levels of external debt and bank loans, they did not manifest any investment–cash flow sensitivity in the pre-crisis period, which indicates that they were probably not financially constrained at all. After the 2008 crisis, companies that would later declare bankruptcy began to become financially constrained as well.
Regression models relating investment demand with firms' Tobin's q and cash flow are fraught with measurement errors which, in turn, cause endogeneity bias. We propose a solution to this problem based on modelling the interaction between the endogenous Tobin's q and the error term in the investment equation as a function of lagged values of Tobin's q. We then study the identification conditions and asymptotic properties of the resulting estimator. Our analysis of a panel of U.S. firms reveals a larger effect of Tobin's q on firms' investment demand than that obtained using available estimators in the literature. Moreover, the estimates highlight the importance of cash flow. We find mixed evidence on the relationship between investment demand and firms' cash flow with respect to different measures of financial constraints. Nevertheless, this evidence is more supportive of the view that firms' cash
flows have a weaker correlation to investment demand when financial conditions tighten.
This paper develops estimation and inference for quantile regression models with measurement errors. We propose an easily-implementable semiparametric two-step estimator when repeated measures for the covariates are available. Building on recent theory on Z-estimation with infinite-dimensional parameters, consistency and asymptotic normality of the proposed estimator are established. We also develop statistical inference procedures and show the validity of a bootstrap approach to implement the methods in practice. Monte Carlo simulations assess the finite-sample performance of the proposed methods. We apply the methods to the investment equation model using a firm-level data with repeated measures of investment demand, Tobin's q. We document strong heterogeneity in the sensitivity of investment to Tobin's q and cash flow across the conditional distribution of investment. The cash flow sensitivity is relatively larger at the lower part of the distribution, providing evidence that these firms are more exposed to and dependent on fluctuations in internal finance.
We propose a procedure for the detection of multiple outliers in multivariate data. Let X be an n × p data matrix representing n observations on p variates. We first order the n observations, using an appropriately chosen robust measure of outlyingness, then divide the data set into two initial subsets: a `basic' subset which contains p + 1 `good' observations and a `non-basic' subset which contains the remaining n - p - 1 observations. Second, we compute the relative distance from each point in the data set to the centre of the basic subset, relative to the (possibly singular) covariance matrix of the basic subset. Third, we rearrange the n observations in ascending order accordingly, then divide the data set into two subsets: a basic subset which contains the first p + 2 observations and a non-basic subset which contains the remaining n - p - 2 observations. This process is repeated until an appropriately chosen stopping criterion is met. The final non-basic subset of observations is declared an outlying subset. The procedure proposed is illustrated and compared with existing methods by using several data sets. The procedure is simple, computationally inexpensive, suitable for automation, computable with widely available software packages, effective in dealing with masking and swamping problems and, most importantly, successful in identifying multivariate outliers.
We test a catering theory describing how stock market mispricing might influence individual firms' investment decisions. We
use discretionary accruals as our proxy for mispricing. We find a positive relation between abnormal investment and discretionary
accruals; that abnormal investment is more sensitive to discretionary accruals for firms with higher R&D intensity (opaque
firms) or share turnover (firms with shorter shareholder horizons); that firms with high abnormal investment subsequently
have low stock returns; and that the larger the relative price premium, the stronger the abnormal return predictability. We
show that patterns in abnormal returns are stronger for firms with higher R&D intensity or share turnover.
We consider a multiple mismeasured regressor errors-in-variables model where the measurement and equation errors are independent and have moments of every order but otherwise are arbitrarily distributed. We present parsimonious two-step generalized method of moments (GMM) estimators that exploit overidentifying information contained in the high-order moments of residuals obtained by partialling out perfectly measured regressors. Using high-order moments requires that the GMM covariance matrices be adjusted to account for the use of estimated residuals instead of true residuals defined by population projections. This adjustment is also needed to determine the optimal GMM estimator. The estimators perform well in Monte Carlo simulations and in some cases minimize mean absolute error by using moments up to seventh order. We also determine the distributions for functions that depend on both a GMM estimate and a statistic not jointly estimated with the GMM estimate.
Most empirical models of investment rely on the assumption that firms are able to respond to prices set in centralized securities markets (through the "cost of capital" or "q"). An alternative approach emphasizes the importance of cash flow as a determinant of investment spending, because of a "financing hierarchy," in which internal finance has important cost advantages over external finance. We build on recent research concerning imperfections in markets for equity and debt. This work suggests that some firms do not have sufficient access to external capital markets to enable them to respond to changes in the cost of capital, asset prices, or tax-based investment incentives. To the extent that firms are constrained in their ability to raise funds externally, investment spending may be sensitive to the availability of internal finance. That is, investment may display "excess sensitivity" to movements in cash flow. In this paper, we work within the q theory of investment, and examine the importance of a financing hierarchy created by capital-market imperfections. Using panel data on individual manufacturing firms, we compare the investment behavior of rapidly growing firms that exhaust all of their internal finance with that of mature firms paying dividends. We find that q values remain very high for significant periods of time for firms paying no dividends, relative to those for mature firms. We also find that investment is more sensitive to cash flow for the group of firms that our model implies is most likely to face external finance constraints. These results are consistent with the augmented model we propose, which takes into account different financing regimes for different groups of firms. Some extensions and implications for public policy are discussed at the end.
Suppose that a firm receives a cash windfall which does not change its investment opportunity set, or equivalently its marginal Tobin's Q. What will this firm do with the money? We provide empirical answers to this question using a sample of firms with such windfalls in the form of a won or settled lawsuit. We examine a variety of decisions of the firm to shed light on alternative theories of corporate financing and investment. Our evidence is broadly inconsistent with the perfect capital markets model. The results need to be stretched considerably to fit the asymmetric information model in which managers act in the interest of shareholders. The evidence supports the agency model of managerial behavior, in which managers try to ensure the long run survival and independence of the firms with themselves at the helm.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
We use earnings forecasts from securities analysts to construct more accurate measures of the fundamentals that affect the expected returns to investment. We find that investment responds significantly -- in both economic and statistical terms -- to our new measures of fundamentals. Our estimates imply that the elasticity of the investment-capital ratio with respect to a change in fundamentals is generally greater than unity. In addition, we find that internal funds are uncorrelated with investment spending, even for selected subsamples of firms -- those paying no dividends and those without bond ratings -- that have been found to be "liquidity constrained" in previous studies. Our results cast doubt on the evidence for liquidity constraints from the many studies that have used Tobin's Q to control for the expected returns to investment.
We propose a procedure for the detection of multiple outliers in multivariate data. Let X be an n × p data matrix representing n observations on p variates. We first order the n observations, using an appropriately chosen robust measure of outlyingness, then divide the data set into two initial subsets: A ‘basic’ subset which contains p +1 ‘good’ observations and a ‘non‐basic’ subset which contains the remaining n ‐ p ‐ 1 observations. Second, we compute the relative distance from each point in the data set to the centre of the basic subset, relative to the (possibly singular) covariance matrix of the basic subset. Third, we rearrange the n observations in ascending order accordingly, then divide the data set into two subsets: A basic subset which contains the first p + 2 observations and a non‐basic subset which contains the remaining n ‐ p ‐ 2 observations. This process is repeated until an appropriately chosen stopping criterion is met. The final non‐basic subset of observations is declared an outlying subset. The procedure proposed is illustrated and compared with existing methods by using several data sets. The procedure is simple, computationally inexpensive, suitable for automation, computable with widely available software packages, effective in dealing with masking and swamping problems and, most importantly, successful in identifying multivariate outliers.
We modify a method for identifying outliers in multivariate samples proposed by Hadi. A simulation study shows that this modification controls the size of the test, leads to substantially improved power and is more effective in dealing with the masking and swamping problems.
We study the investment–cash flow sensitivities of U.S. firms from 1971–2009. Our tests extend the literature in several key ways and provide strong evidence that cash flow explains investment beyond its correlation with q . A dollar of current- and prior-year cash flow is associated with 0.63 of additional investment for firms that are the most likely to be constrained, even after correcting for measurement error in q . Our results suggest that financing constraints and free-cash-flow problems are important for investment decisions.
We construct an index of firms’ external finance constraints via generalized method of moments (GMM) estimation of an investment
Euler equation. Unlike the commonly used KZ index, ours is consistent with firm characteristics associated with external finance
constraints. Constrained firms’ returns move together, suggesting the existence of a financial constraints factor. This factor
earns a positive but insignificant average return. Much of the variation in this factor cannot be explained by the Fama–French
and momentum factors. Cross-sectional regressions of returns on our index and other firm characteristics show that constrained
firms earn higher returns and that the financial-constraints effect dominates the size effect.
which the relationships are not exact, so that a set of ideal economic variables is assumed to be generated by a set of dynamic stochastic relationships, as in Koopmans [12], and the actual economic time series are assumed to differ from the ideal economic variables because of random disturbances or measurement errors. The asymptotic error variance matrix for the coefficients of one of the relationships is obtained in the case in which these relationships are estimated using instrumental variables. With this variance matrix we are able to discuss the problem of choice that arises when there are more instrumental variables available than the minimum number required to enable the method to be used. A method of estimation is derived which involves a characteristic equation already considered by Hotelling in defining the canonical correlation [10]. This method was previously suggested by Durbin [7]. The same estimates would be obtained by the maximum-likelihood limited
Many recent empirical investment studies have found that the investment of financially constrained firms responds strongly to cash flow. Paralleling these findings is the disappointing performance of the q theory of investment: even though marginal q should summarize the effects of all factors relevant to the investment decision, cash flow still matters. We examine whether this failure is due to error in measuring marginal q. Using measurement error-consistent generalized method of moments estimators, we find that most of the stylized facts produced by investment-q cash flow regressions are artifacts of measurement error. Cash flow does not matter, even for financially constrained firms, and despite its simple structure, q theory has good explanatory power once purged of measurement error.
We modify a method for identifying outliers in multivariate samples proposed by Hadi. A simulation study shows that this modification controls the size of the test, leads to substantially improved power and is more effective in dealing with the masking and swamping problems.
Investment-cash flow sensitivity has declined and disappeared, even during the 2007-2009 credit crunch. If one believes that financial constraints have not disappeared, then investment-cash flow sensitivity cannot be a good measure of financial constraints. The decline and disappearance are robust to considerations of R&D and cash reserves, and across groups of firms. The information content in cash flow regarding investment opportunities has declined, but measurement error in Tobin’s q does not completely explain the patterns in investment-cash flow sensitivity. The decline and disappearance cannot be explained by changes in sample composition, corporate governance, or market power; and remain a puzzle.
Almeida, Campello, and Galvao (2010) [ACG] use Monte Carlo simulations and real data to assess the performance of estimators that deal with measurement errors in investment models. ACG are the first to provide an independent assessment of alternative methods, showing when they work properly and discussing the assumptions embedded in them. Erickson and Whited (2010) review ACG's study focusing exclusively on tests involving the Erickson and Whited (2000, 2002) [EW] estimator. While casting doubt on the usefulness of the ACG analysis, Erickson and Whited (2010) develop a number of ex-post fixes for the problems uncovered by ACG. The authors argue that the ACG tests would place the EW estimator in a more positive light had they used those fixes. This paper evaluates the new fixes proposed by Erickson and Whited and clarifies their implications for the debate about measurement error. The analysis provides further support for ACG's main conclusion: the presence of measurement error does not justify the use of the EW estimator in lieu of more robust, simpler alternatives.
The study of the investment-cash flow (ICF) sensitivity constitutes one of the largest literatures in corporate finance, yet little is known about changes in the ICF relationship over time, and the literature has largely ignored how rising R&D investment and developments in equity markets have impacted ICF sensitivity estimates. We show that for the time period 1970-2006, the ICF sensitivity: (i) largely disappears for physical investment, (ii) remains comparatively strong for R&D, and (iii) declines, but does not disappear, for total investment. We argue that these findings can largely be explained by the changing composition of investment and the rising importance of public equity as a source of funds, particularly for firms with persistent negative cash flows.
This paper considers the consistent estimation of nonlinear errors-in-variables models. It adopts the functional modeling approach by assuming that the true but unobserved regressors are random variables but making no parametric assumption on the distribution from which the latent variables are drawn. This paper shows how the information extracted from the replicate measurements can be used to identify and consistently estimate a general nonlinear errors-in-variables model. The identification is established through characteristic functions. The estimation procedure involves nonparametric estimation of the conditional density of the latent variables given the measurements using the identification results at the first stage, and at the second stage, a semiparametric nonlinear least-squares estimator is proposed. The consistency of the proposed estimator is also established. Finite sample performance of the estimator is investigated through a Monte Carlo study.
Estimation for the nonlinear errors-in-variables model is considered. It isassumed that additional information is available in the form of observations on instrumental variables. An estimation procedure is presented for the parameters of the model. Asymptotic properties of the estimator are investigated.
Kaplan and Zingales [Quart. J. Econ. 112 (1997) 169] and Clearly [J. Finance 54 (2) (1999) 673] diverge from the large literature on investment–cash flow sensitivity by showing that investment is most sensitive to cash flow for the least financially constrained firms. We examine if this result can be explained by the fact that when firms are in sufficiently bad shape (incurring cash losses), investment cannot respond to cash flow. We find that while Cleary's results can be explained by such negative cash flow observations, the Kaplan–Zingales results are driven more by a few influential observations in a small sample. We also record a decline in investment–cash flow sensitivity over the 1977–1996 period, particularly for the most constrained firms.
This paper presents specification tests that are applicable after estimating a dynamic model from panel data by the generalized
method of moments (GMM), and studies the practical performance of these procedures using both generated and real data. Our
GMM estimator optimally exploits all the linear moment restrictions that follow from the assumption of no serial correlation
in the errors, in an equation which contains individual effects, lagged dependent variables and no strictly exogenous variables.
We propose a test of serial correlation based on the GMM residuals and compare this with Sargan tests of over-identifying
restrictions and Hausman specification tests.
We collect detailed qualitative information from financial filings to categorize financial constraints for a random sample
of firms from 1995 to 2004. Using this categorization, we estimate ordered logit models predicting constraints as a function
of different quantitative factors. Our findings cast serious doubt on the validity of the KZ index as a measure of financial
constraints, while offering mixed evidence on the validity of other common measures of constraints. We find that firm size
and age are particularly useful predictors of financial constraint levels, and we propose a measure of financial constraints
that is based solely on these firm characteristics.
A Q model of investment is estimated using data for an unbalanced panel of UK companies over the period 1975-86. Correlated firm-specific effects and the endogeneity of Q are allowed for using a Generalised Method of Moments estimator. In the calculation of Q we estimate the tax incentives available to individual companies. Q is found to be a significant factor in the explanation of company investment, although its effect is small and a careful treatment of the dynamic structure of Q models appears critical. In addition to Q, both cash flow and output variables are found to play an independent and significant role.
No. This paper investigates the relationship between financing constraints and investment-cash flow sensitivities by analyzing
the firms identified by Fazzari, Hubbard, and Petersen as having unusually high investment-cash flow sensitivities. We find
that firms that appear less financially constrained exhibit significantly greater sensitivities than firms that appear more
financially constrained. We find this pattern for the entire sample period, subperiods, and individual years. These results
(and simple theoretical arguments) suggest that higher sensitivities cannot be interpreted as evidence that firms are more
financially constrained. These findings call into question the interpretation of most previous research that uses this methodology.
The financing of R&D provides a potentially important channel to link finance and economic growth, but there is no direct evidence that financial effects are large enough to impact aggregate R&D. U.S. firms finance R&D from volatile sources: cash flow and stock issues. We estimate dynamic R&D models for high-tech firms and find significant effects of cash flow and external equity for young, but not mature, firms. The financial coefficients for young firms are large enough that finance supply shifts can explain most of the dramatic 1990s R&D boom, which implies a significant connection between finance, innovation, and growth. Copyright (c) 2009 The American Finance Association.
Pledgeable assets support more borrowing, which allows for further investment in pledgeable assets. We use this credit multiplier
to identify the impact of financing frictions on corporate investment. The multiplier suggests that investment–cash flow sensitivities
should be increasing in the tangibility of firms' assets (a proxy for pledgeability), but only if firms are financially constrained.
Our empirical results confirm this theoretical prediction. Our approach is not subject to the Kaplan and Zingales (1997) critique, and sidesteps problems stemming from unobservable variation in investment opportunities. Thus, our results strongly
suggest that financing frictions affect investment decisions.
Tobin’s q is widely accepted as proxy for an underlying “true” q, which is assumed to characterize a firm’s incentive to invest. Researchers have developed numerous methods for computing q. This article assesses the measurement quality of different proxies for q. We adapt the measurement-error consistent estimators in Erickson and Whited (2002) to estimate the extent to which variation in true unobservable q explains variation in different proxies for q. We find most proxies for q are poor: careful algorithms for calculating q do little to improve measurement quality. Using elaborate algorithms, however, depletes the number of usable observations and possibly introduces sample selection bias.
This paper studies estimators that make sample analogues of population orthogonality conditions close to zero. Strong consistency and asymptotic normality of such estimators is established under the assumption that the observable variables are stationary and ergodic. Since many linear and nonlinear econometric estimators reside within the class of estimators studied in this paper, a convenient summary of the large sample properties of these estimators, including some whose large sample properties have not heretofore been discussed, is provided.
Identification in errors-in-variables regression models was recently extended to wide models classes by S. Schennach (Econometrica, 2007) (S) via use of generalized functions. In this paper the problems of non- and semi- parametric identification in such models are re-examined. Nonparametric identification holds under weaker assumptions than in (S); the proof here does not rely on decomposition of generalized functions into ordinary and singular parts, which may not hold. Conditions for continuity of the identification mapping are provided and a consistent nonparametric plug-in estimator for regression functions in the L₁ space constructed. Semiparametric identification via a finite set of moments is shown to hold for classes of functions that are explicitly characterized; unlike (S) existence of a moment generating function for the measurement
Identification in errors-in-variables regression models was recently extended to wide models classes by S. Schennach (Econometrica, 2007) (S) via use of generalized functions. In this paper the problems of non- and semi- parametric identification in such models are re-examined. Nonparametric identification holds under weaker assumptions than in (S); the proof here does not rely on decomposition of generalized functions into ordinary and singular parts, which may not hold. Conditions for continuity of the identification mapping are provided and a consistent nonparametric plug-in estimator for regression functions in the L₁ space constructed. Semiparametric identification via a finite set of moments is shown to hold for classes of functions that are explicitly characterized; unlike (S) existence of a moment generating function for the measurement
Observations on N cross-section units at T time points are used to estimate a simple statistical model involving an autoregressive process with an additive term specific to the unit. Different assumptions about the initial conditions are (a) initial state fixed, (b) initial state random, (c) the unobserved individual effect independent of the unobserved dynamic process with the initial value fixed, and (d) the unobserved individual effect independent of the unobserved dynamic process with initial value random. Asymptotic properties of the maximum likelihood and “covariance” estimators are obtained when T → ∞ and when N → ∞. The relationship between the pseudo and conditional maximum likelihood estimators is clarified. A simple consistent estimator that is independent of the initial conditions and the way in which T or N → ∞ is also suggested.
This paper presents a solution to an important econometric problem, namely the root n consistent estimation of nonlinear models with measurement errors in the explanatory variables, when one repeated observation of each mismeasured regressor is available. While a root n consistent estimator has been derived for polynomial specifications (see Hausman, Ichimura, Newey, and Powell (1991)), such an estimator for general nonlinear specifications has so far not been available. Using the additional information provided by the repeated observation, the suggested estimator separates the measurement error from the "true" value of the regressors thanks to a useful property of the Fourier transform: The Fourier transform converts the integral equations that relate the distribution of the unobserved "true" variables to the observed variables measured with error into algebraic equations. The solution to these equations yields enough information to identify arbitrary moments of the "true," unobserved variables. The value of these moments can then be used to construct any estimator that can be written in terms of moments, including traditional linear and nonlinear least squares estimators, or general extremum estimators. The proposed estimator is shown to admit a representation in terms of an influence function, thus establishing its root n consistency and asymptotic normality. Monte Carlo evidence and an application to Engel curve estimation illustrate the usefulness of this new approach. Copyright Econometric Society 2004.
This paper considers estimation and testing of vector autoregressio n coefficients in panel data, and applies the techniques to analyze the dynamic relationships between wages an d hours worked in two samples of American males. The model allows for nonstationary individual effects and is estimated by applying instrumental variables to the quasi-differenced autoregressive equations. The empirical results suggest the absence of lagged hours in the wage forecasting equation. The results also show that lagged hours is important in the hours equation. Copyright 1988 by The Econometric Society.
Firm investment decisions are shown to be directly related to financial factors. Investment decisions of firms with high creditworthiness (according to traditional financial ratios) are extremely sensitive to the availability of internal funds; less creditworthy firms are much less sensitive to internal fund availability. This large sample evidence is based on an objective sorting mechanism and supports the results of Kaplan and Zingales (1997), who also find that investment outlays of the least constrained firms are the most sensitive to internal cash flow. Copyright The American Finance Association 1999.
Using data from the 1986 oil price decrease, the author examines the capital expenditures of nonoil subsidiaries of oil companies. He tests the joint hypothesis that (1) a decrease in cash/collateral decreases investment, holding fixed the profitability of investment, and (2) the finance costs of different parts of the same corporation are independent. The results support this joint hypothesis: oil companies significantly reduced their nonoil investment compared to the median industry investment. The 1986 decline in investment was concentrated in nonoil units that were subsidized by the rest of the company in 1985. Copyright 1997 by American Finance Association.
This paper presents evidence supporting the theory that problems of asymmetric information in debt markets affect financially unhealthy firms' ability to obtain outside finance and, consequently, their allocation of real investment expenditure over time. The author tests this hypothesis by estimating the Euler equation of an optimizing model of investment. Including the effect of a debt constraint greatly improves the Euler equation's performance in comparison to the standard specification. When the sample is split on the basis of two measures of financial distress, the standard Euler equation fits well for the a priori unconstrained.groups, but is rejected for the others. Copyright 1992 by American Finance Association.
Two easily measured variables, size and book-to-market equity, combine to capture the cross-sectional variation in average stock returns associated with market "beta", size, leverage, book-to-market equity, and earnings-price ratios. Moreover, when the tests allow for variation in "beta" that is unrelated to size, t he relation between market "beta" and average return is flat, even when "beta" is the only explanatory variable. Copyright 1992 by American Finance Association.
The Stock Market and Investment in the New Economy: Some Tangible Facts and Intangible Fictions In the Old Economy, the value of a company was mostly in its hard assets—its buildings, machines, and physical equipment. In the New Economy, the value of a company derives more from its intangibles—its human capital, intellectual property, brainpower, and heart. In a market economy, it’s no surprise that markets themselves have begun to recognize the potent power of intangibles. It’s one reason that net asset values of companies are so often well below their market capitalization. —Vice President Al Gore, speech at the Microsoft CEO Summit, May 8, 1997 I think there is such an overvaluation of technology stocks that it is absurd . . . and I’d put our company’s stock in that category. —Steve Ballmer, president of Microsoft Corporation, quoted in the Wall Street Journal, p. C1, September 24, 1999 BROADLY SPEAKING, there are two opposing views about the relationship between the stock market and the new economy. In one view, expressed in the quotation from Vice President Gore, intangible investment helps explain why companies’ market values are so much greater than the values of their tangible assets. In the other view, expressed, ironically, by the president of one of the leading firms in the new economy, stock market 61 STEPHEN R. BOND Institute for Fiscal Studies, London JASON G. CUMMINS New York University 9573—03 BPEA Bond/Cummins 7/21/00 10:20 Page 61 valuations have become unhinged from company fundamentals.1 Whatever the motivations of Gore and Ballmer in making these comments, their perspectives frame the debate about the relationship between the stock market and the new economy. One way to start thinking about this relationship is in terms of the theory of stock market efficiency. When the stock market is strongly efficient, the market value of a company is, at every instant, equal to its fundamental value, defined as the expected present discounted value of future payments to shareholders. If we abstract from adjustment costs and market power, we can highlight the central role that strong stock market efficiency plays: it equates the company’s market value to its enterprise value—that is, the replacement cost of its assets. However, the most readily available measure of enterprise value in a company’s accounts, the book value of tangible assets, is typically just a fraction of the company’s market value. For companies in the new economy, book value is an even smaller fraction of market value, because these companies rely more on intangible assets than old economy companies do. Hence, the rest of this enterprise value must come from adjusting for the replacement cost of tangible assets and including intangible assets. When price inflation, economic depreciation, and technical progress are modest, the difference between the replacement cost and the book value of tangible assets is relatively small.2 This means that intangibles account for the remaining difference. 62 Brookings Papers on Economic Activity, 1:2000 We thank participants at the Brookings Panel on Economic Activity and Tor Jakob Klette for helpful comments and suggestions. We also thank Haibin Jiu for his superb research assistance. Stephen Bond gratefully acknowledges financial support from the ESRC Centre for Fiscal Policy at the Institute for Fiscal Studies. Jason Cummins gratefully acknowledges financial support from the C. V. Starr Center for Applied Economics. The data on earnings expectations are provided by I/B/E/S International Inc. 1. In his public comments, Ballmer consistently emphasizes this point, saying, for example, that market participants’ expectations about Microsoft’s growth are “outlandish and crazy,” because Microsoft has “more competition than we ever have had before” (www.microsoft.com/msft/speech/analystmtg99/ballmerfam99.htm). 2. Economic depreciation and technical progress affect the relationship between book value and replacement cost in the opposite way from price inflation. Rapid inflation makes the book value of assets less than their value at current prices, whereas rapid economic depreciation and technical progress cause the book value of assets to exceed their value in quality-adjusted prices. In this sense, book value may actually exceed replacement cost for certain types of capital goods that have experienced rapid depreciation...
This article provides evidence that financial development impacts growth by reducing financing constraints that would otherwise
distort efficient allocation of investment. The financing constraints are inferred from the investment Euler equation by assuming
that the firm's stochastic discount factor is a function of the firm's financial position (specifically, the stock of liquid
assets). The magnitude of the changes in the cost of capital is twice as large in a country with a low level of financial
development as in a country with an average level of financial development. The size effect, business cycles, and legal environment
effects are also considered.
Comment on ‘Financing Constraints and Corporate Investment
- Poterba