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

See all articles by Jacinto Marabel Romo

Jacinto Marabel Romo

Grupo Banco Bilbao Vizcaya Argentaria (BBVA); Department of Management Sciences, University of Alcalá

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 fi nance, Euler equation, user cost of capital, measurement error, Generalized Method of Moments

JEL Classification: C2, C23, C26, G1

Suggested Citation

Marabel Romo, Jacinto, Investment Decisions with Financial Constraints: Evidence from Spanish Firms (December 1, 2010). Quantitative Finance 14 (2014) 1079-1095, Available at SSRN: https://ssrn.com/abstract=2231224

Jacinto Marabel Romo (Contact Author)

Grupo Banco Bilbao Vizcaya Argentaria (BBVA) ( email )

c/ Sauceda, 28
Madrid
Spain

Department of Management Sciences, University of Alcalá ( email )

Plaza de la Victoria s/n
Alcala de Henares, Madrid 28802
Spain

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