Financing Constraints and Corporate Investment
Posted: 17 Nov 2009
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Financing Constraints and Corporate Investment
Date Written: 1988
Abstract
Discusses the connection between conventional models of business investment and the literature on the imperfections in capital markets and the differences in individual firms' abilities to access these markets. Financing methods considered in this analysis include short-term bank debt, long-term bank debt, other long-term debt, and retained earnings. The financing methods used by manufacturing firms between 1970 and 1984 are summarized in the aggregate. The cost of internal financing is often less than external financing because of transaction costs, tax advantages, agency problems, and asymmetric information. This cost premium for external financing is integrated into an existing model of firm financial and investment decisions that has been developed in previous literature in order to create a financing hierarchy model. Data used in the empirical analysis were collected from 422 manufacturing firms. These firms are divided into three classes based on their dividend to income ratio. Results show that firms that retain most of their income have a greater sensitivity of investment to cash flow and liquidity. Firms that were young and had low dividends were most affected. The differences across firms are consistent with financial constraints arising from capital market imperfections. The impact that economic fluctuations and tax policy have on investment are also considered. (SRD)
Keywords: Capital investment, Tax policies, Investment policies, Financial markets, Market constraints, Debt financing, Earnings, Manufacturing industries, Financial constraints, Access to capital, Firm financing
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