Investment-Cash Flow Sensitivity – A Focus on the Panel-Data Econometrics Involved

Abstract

I revisit Fazzari et al. (1988) seminal paper on the investment-cash flow sensitivity as a measure of financing constraints and augment their approach with the findings from recent papers. I find that the investment-cash flow sensitivity has decreased and mostly disappeared over time, in line with recent literature. This finding is robust to alternative specifications and a number of robustness checks. I contribute to the literature by explicitly analyzing the strict-exogeneity assumption of the fixed-effects and first-differences estimators in empirical practice. In this setting, strict exogeneity does not hold and the violation can cause substantial inconsistencies. 

Keywords: Investment-cash flow sensitivity; Capital market imperfections; Strict exogeneity; Panel data