The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities


  • Vladimir Gatchev is at the University of Central Florida, College of Business; Todd Pulvino is at CNH Partners, LLC and is adjunct professor of Finance at Northwestern University, Kellogg School of Management; and Vefa Tarhan is at Loyola University Chicago, School of Business and is visiting professor of Finance at Northwestern University, Kellogg School of Management. We thank Matthew Billett, Tim Bollerslev, Michael Fishman, Jon Garfinkel, Charles Himmelberg, Ravi Jagannathan, Robert Korajczyk, Nicholas Lash, Iwan Meier, Tom Nohel, Artur Raviv, Paola Sapienza, Ernst Schaumburg, Paul Spindt, Steven Todd, Toni Whited, and seminar participants at DePaul University, the Federal Reserve Bank of Chicago, the Financial Management Association, HEC Montréal, Loyola University Chicago, Northwestern University, Tulane University, and the University of Iowa for useful discussions. We are especially thankful to Robert Stambaugh (the Editor), an anonymous associate editor, and an anonymous referee for their insightful comments that significantly improved the paper. Please address correspondence to Vefa Tarhan.


We develop a dynamic multiequation model where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates, and that models that do not acknowledge the interdependence among decision variables produce inefficient estimates and provide an incomplete and potentially misleading view of financial behavior. We use our model to examine whether firms are constrained from accessing capital markets. Unlike static single-equation studies that find firms underinvest given cash flow shortfalls, we conclude that firms maintain investment by borrowing.