Working Capital and Fixed Investment: New Evidence on Financing Constraints

Abstract

This article presents new tests for finance constraints on investment by emphasizing the often-neglected role of working capital as both a use and a source of funds. The coefficient of endogenous working capital investment is negative in a fixed-investment regression, as expected if working capital competes with fixed investment for a limited pool of finance. This finding addresses a criticism of previous research on finance constraints, that cash flows may simply proxy shifts in investment demand. In addition, previous studies may have underestimated the impact of finance constraints on growth and investment because firms smooth fixed investment in the short run with working capital.