Year: 2009
Type: article
Abstract: In this article we describe a model of optimal investment of various types of financially constrained firms. We show that the resulting relationship between internal funds and investment is nonmonotonic. In particular, the magnitude of Cash Flow (CF) sensitivity of the investment is lower for the firms with credit rationing compared to the firms that are able to obtain short-term external financing. The inverse relationship is driven by the leverage multiplier effect. A positive CF shock increases the short-term borrowing capacity of the firm, which in turn has a positive effect on investment and the 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 contrasting findings in the financial constraints literature.
Source: Applied Financial Economics
Authors: Rozália Pál, Roman Kozhan
Institutions: European University Viadrina, University of Warwick
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W1983794759