Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/108102
Authors: 
Pál, Rozália
Kozhan, Roman
Year of Publication: 
2006
Series/Report no.: 
IEHAS Discussion Papers MT-DP - 2006/6
Abstract: 
In this paper we describe a theoretical model of optimal investment of various types of financially constrained firms. We show that the resulting relationship between internal funds and investment is non-monotonic. In particular, the magnitude of the cash flow sensitivity of the investment is lower for firms with credit rationing compared to firms that are able to obtain short-term external financing. The inverse relationship is driven by the leverage multiplier effect. A positive cash flow shock increases the short-term borrowing capacity of the firm, which in turn has a positive effect on investment and firm's growth. Moreover, the leverage multiplier effect is the highest for firms relying on short-term credits and it is lower for firms that are able to obtain long-term financing. Analysing a large euro area data set we find strong empirical support for our theoretical predictions. The results also help to explain some contradictory findings in the financing constraints literature.
Subjects: 
Financing constraints
growth
investment
cash flow sensitivity
JEL: 
D92
G3
G32
ISBN: 
9639588776
Document Type: 
Working Paper

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