734 - Corporate Investment and Financing Constraints: Connections with Cash Management

Wetenschappelijke publicatie
Date 1 May 2003

The empirical application of the financing constraints paradigm supports the joint hypothesis that constrained firms can be identified and display a stronger sensitivity of investment to cash flow. This paradigm is increasingly criticized, because some proxy variables used to identify constrained firms deliver contradictory results regarding this sensitivity. In addition, some of the firms that display a strong sensitivity have internal funds seemingly in abundance. In this paper, I propose to take a closer look at what constitutes a constrained firm. I do so by considering firms’ responses in terms of cash management to the possibility of financing constraints. A fertile area of empirical research addresses the determination of corporate cash holdings and finds that firms specify cash targets partially for circumventing the brunt of future financing constraints. I argue that knowledge of such targets allows for a more precise identification of which firms face financing constraints, because it allows us to measure the amount of ’free cash’ that firms have at their disposal. Keywords: Corporate investment, financing constraints, corporate cash JEL Codes: E41, G31, G32