Investment Decisions with Financial Constraints: Evidence from Spanish Firms
Quantitative Finance 14 (2014) 1079-1095
39 Pages Posted: 11 Mar 2013 Last revised: 28 Aug 2014
Date Written: December 1, 2010
Abstract
This paper analyzes to what extent the rejection of the investment dynamics implied by the Euler equation model with quadratic and symmetric adjustment costs can be attributed to the fact that the investment behavior of some firms in some periods is financially constrained by the availability of internal funds. I use a hierarchy of finance model which assumes that internally generated finance for investment is available at a lower cost than external finance and implies the existence of distinct financial regimes depending on the firm's financial policy.
I estimate the empirical investment equation derived from the model using GMM, taking into account the endogeneity of the selection and allowing for debt finance, imperfect competition and the existence of a possible measurement error in the user cost of capital. The empirical results suggest that the Euler equation model is not seriously misspecified for a sub-sample of firms pursuing a particular financial policy.
Keywords: hierarchy of finance, Euler equation, user cost of capital, measurement error, Generalized Method of Moments
JEL Classification: C2, C23, C26, G1
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