Cash Flow and Investment: Evidence from Internal Capital Markets



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    • Graduate School of Business, University of Chicago. I thank the National Science Foundation and the Alfred P. Sloan Foundation for financial support, and Andrew Bernard, Olivier Jean Blanchard, David Brown, Ricardo Caballero, Judith Chevalier, Robert S. Chirinko, Guy Debelle, Charles Hadlock, Paul Healy, Anil Kashyap, Jim Poterba, David Scharfstein, Jeremy Stein, René Stulz, David Wilcox, an anonymous referee, and seminar participants at numerous institutions for helpful comments, and Amy C. Ko and Sydney Ludvigson for research assistance.


Using data from the 1986 oil price decrease, I examine the capital expenditures of nonoil subsidiaries of oil companies. I test the joint hypothesis that 1) a decrease in cash/collateral decreases investment, holding fixed the profitability of investment, and 2) the finance costs of different parts of the same corporation are interdependent. The results support this joint hypothesis: oil companies significantly reduced their nonoil investment compared to the median industry investment. The 1986 decline in investment was concentrated in nonoil units that were subsidized by the rest of the company in 1985.