Firms' investment under financing constraints. An euro area investigation

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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.

Object Details

• ISBN: 9639588776
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: IEHAS Discussion Papers ; No. MT-DP - 2006/6

Classification and Topics

• Classification: Wirtschaft ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
• Subject: Financing constraints ; growth ; investment ; cash flow sensitivity ; Investition ; Budgetrestriktion ; Cash Flow ; Theorie ; Schätzung ; EU-Staaten

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Pál, Rozália ; Kozhan, Roman
• Event: Veröffentlichung
• (who): Hungarian Academy of Sciences, Institute of Economics
• (where): Budapest
• (when): 2006

Further information

• Handle: http://hdl.handle.net/10419/108102
• Last update: 10.03.2025, 11:44 AM CET