Fixed investment, liquidity, and access to capital markets: New evidence

We re-evaluate the cash flow-investment relation from a new angle in a setting where the firm can access capital markets and faces different investment opportunity sets. Instead of replying on cash flow, we introduce other forms of finance to interact with investment. We find that financial variables enter significantly into the investment regressions at different timing. The cash flow effect reduces after the IPO and especially after the SEO, but remains positive for the firm with greater investment opportunities. Similar reductions in the long-term debt effect and especially in the working capital effect are also identified. The reductions are more pronounced in SMEs than in large firms. We draw the following conclusions. First, the cash flow-investment relation is not constant but evolves. Different forms of finance play concomitant roles covering cash flow shortfalls, jointly determining the dynamics of investment. Second, the investment-cash flow sensitivities do not constitute evidence of external financial constraints. Rather, the excess sensitivities are a response to the investment policy that is to drive asset growth or to maintain business operations. Essentially, growth opportunities are not in the cash flow terms but are embedded in the investment policy. Our study offers an alternative explanation for the investment-cash flow sensitivities.

► We re-evaluate the cash flow-investment relation in a setting where firms can access capital markets and face different investment opportunity sets. ► This relation evolves. Different forms of finance play concomitant roles covering cash flow shortfalls, jointly determining investment. ► The investment-cash flow sensitivities do not constitute evidence of external financial constraints. ► The excess sensitivities are a response to the investment policy that is to drive asset growth or to maintain business operations. ► Growth opportunities are not in the cash flow terms but are embedded in the firm's investment policy.