Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?

TLDR

The study investigates the relationship between financing constraints and investment‑cash flow sensitivities by analyzing firms identified by Fazzari, Hubbard, and Petersen as having unusually high sensitivities. The authors analyze these firms to assess how financing constraints relate to investment‑cash flow sensitivities. They find that firms appearing less financially constrained exhibit significantly greater sensitivities, a pattern that persists across periods and suggests that high sensitivities do not indicate financial constraints, thereby questioning prior research that uses this methodology. No.

Abstract

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.