How Sensitive Is Investment to Cash Flow When Financing Is Frictionless?


  • Aydoḡan Alti

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    • University of Texas at Austin. This paper is based on the first chapter of my dissertation at Carnegie Mellon University. I am indebted to my advisor, Rick Green, for suggesting to me to work on this topic, and my doctoral committee members, Burton Hollifield and Christine Parlour, for their constant guidance and support. I would like to thank Gian Luca Clementi, Chandra Das, Douglas Diamond (the editor), Mike Gallmeyer, Fatih Güvenen Charles Himmelberg, Jacob Oded, Bryan Routledge, Toni Whited, and the participants at the 2001 WFA meetings and 2001 NBER Corporate Finance Workshop for many valuable comments. All remaining errors are mine.


I analyze the sensitivity of a firm's investment to its own cash flow in the benchmark case where financing is frictionless. This sensitivity has been proposed as a measure of financing constraints in earlier studies. I find that the investment–cash flow sensitivities that obtain in the frictionless benchmark are very similar, both in magnitude and in patterns they exhibit, to those observed in the data. In particular, the sensitivity is higher for firms with high growth rates and low dividend payout ratios. Tobin's q is shown to be a more noisy measure of near-term investment plans for these firms.