The Impact of Capital Market Imperfections on Investment-Cash Flow Sensitivity

School of Business, George Washington University, 2201 G Street, Funger Hall 505, Washington, DC 20052, United States
Journal of Banking & Finance (Impact Factor: 1.29). 02/2008; 32(2):207-216. DOI: 10.2139/ssrn.686812
Source: RePEc


We examine the investment-cash flow sensitivity of US manufacturing firms in relation to five factors associated with capital market imperfections - fund flows, institutional ownership, analyst following, bond ratings, and an index of antitakeover amendments. We find a steady decline in the estimated sensitivity over time. Furthermore, we find that investment-cash flow sensitivity decreases with increasing fund flows, institutional ownership, analyst following, antitakeover amendments and with the existence of a bond rating. The overall evidence suggests that investment-cash flow sensitivity decreases with factors that reduce capital market imperfections.

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    • "Regarding internal net cash flow, many previous studies include a measure of internal net cash flow to gauge the effects of financial constraints on external financing of investment, though the justification for doing so has been hotly debated. 4 Fixed effects are also commonly added to account for unobserved factors [4,21,23242544]. While we accept this justification, we suspect that the explanatory power of fixed effects is due, at least in part, to individual firms' differential investment propensities. "

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    • "We examine the sensitivity of expenditure in year t to cash flow in year t within a framework similar to that in Malmendier and Tate (2005). This type of investment-cash-flow sensitivity model has been widely studied in the literature (see e.g., Agca and Mozumdar (2008); Almeida et al. (2004); Brown and Petersen (2009); Fazzari et al. (1988, 2000); Hovakimian "
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    • "Whited, 1992; Gérard and Verschueren, 2003), bonds rating (e.g. Whited, 1992; Gilchrist and Himmelberg, 1995; Agca and Mozumdar, 2008) and interest coverage ratio (e.g. Whited, 1992) constitute some of the proxies used in the assessment of financial constraints. "
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