Financing constraints and firm heterogeneity in investment behaviour: an application of non-nested tests

Abstract

Abstract Estimating an extended qmodel against Canadian panel date it is demonstrated that the usual practice of conditioning tests of financing constraints on the a priorisorting of firms into financially constrained and unconstrained groups may lead to spurious inference about the existence of credit rationing. The sample sorting bias is minimized by empirically determining the best sorting criterion. The results reveal that while liquidity is the most important and robust determinant of corporate investment, the data do not support critical predictions of either the underinvestment or the overinvestment theories.