Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/81876 
Authors: 
Year of Publication: 
2009
Series/Report no.: 
Sveriges Riksbank Working Paper Series No. 228
Publisher: 
Sveriges Riksbank, Stockholm
Abstract: 
This paper tests the balance sheet theory, where the status of balance sheets affects the economy's response to monetary and other shocks. The theory predicts a positive effect of cash flow on investment, given fundamental determinants of investment. I use an empirical method developed by Gilchrist and Himmelberg (1995, 1999), which has previously only been used to study very large, publicly traded firms. In contrast, this paper uses a large Swedish data set with many smaller firms, where balance sheet effects are likely to be especially important. I find that a firm's cash flow has a positive impact on its investment, controlling for any information in cash flow about investment opportunities. As predicted by the balance sheet channel, the estimated effect of cash flow on investment is especially large for firms which, a priori, are more likely to be financially constrained (low-dividend, small and non-group firms). Moreover, the investment-cash flow sensitivity is significantly larger and more persistent during the first half of the sample period, which includes a severe banking crisis and recession, than during the second half.
Subjects: 
financial frictions
balance sheet channel
financial accelerator
investment
cash flow
JEL: 
C33
E22
E44
E55
Document Type: 
Working Paper

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