We would like to thank an anonymous referee, John Doukas (Managing Editor), the participants of European Financial Management Association (2005) and Financial Management Association (2006) annual meetings, as well as the seminar participants at Fordham University and Baruch College for helpful comments.
Cash Flow Sensitivity of Investment
Article first published online: 7 DEC 2007
© 2007 The Authors Journal compilation © 2007 Blackwell Publishing Ltd
European Financial Management
Volume 15, Issue 1, pages 47–65, January 2009
How to Cite
Hovakimian, A. and Hovakimian, G. (2009), Cash Flow Sensitivity of Investment. European Financial Management, 15: 47–65. doi: 10.1111/j.1468-036X.2007.00420.x
- Issue published online: 25 DEC 2008
- Article first published online: 7 DEC 2007
- investment cash flow sensitivity;
- financial constraints;
- managerial overconfidence
Investment cash flow sensitivity is associated with both underinvestment when cash flows are low and overinvestment when cash flows are high. The accessibility of external capital is positively correlated with cash flows, intensifying investment cash flow sensitivity. Managers actively counteract the variations in internal and external liquidity by accumulating working capital when liquidity is high and draining it when liquidity is low. These results imply that cash flow sensitive firms face financial constraints, which are binding in low cash flow years. Traditional indicators of financial constraints, such as size and dividend payout, successfully distinguish firms that may potentially face constraints, but are less successful in distinguishing between periods of tight and relaxed constraints. These periods are much more clearly separated by the KZ index, which, on the other hand, is less successful in identifying firms that are likely to face liquidity constraints.