Cash Flow Sensitivities and Corporate Financing Constraints

Abstract

This thesis examines different aspects of cash flow sensitivities in the context of corporate financing constraints. Despite the extensive body of literature on (i) the sensitivity of investment to cash flow (ICFS) and (ii) the sensitivity of cash to cash flow (CCFS), existing studies offer contrasting and puzzling evidence regarding cash flow sensitivities. The purpose of the thesis is to address some of the issues related to cash flow sensitivities and to contribute in elucidating cash flow sensitivities. The first essay examines the recently documented ICFS puzzle. ICFS has significantly declined and disappeared in the U.S. market over time. However, the decline and disappearance of ICFS have not been explained and remain a puzzle. We argue that improved access to lower cost external financing (substitution between internal cash flow and external funds) and a global shift from asset tangibility to liquidity have largely contributed to the reported decline in ICFS. The results further suggest that firms rely less on both internally generated cash flows as a source of financing and tangible assets as an input of production and thus demonstrate weaker ICFS. The second essay examines the influence of financial development on CCFS. Previous studies have found that corporate saving propensities decrease with financial advances. However, this relationship holds only if CCFS is linear, which is not a valid assumption. CCFS is highly sensitive to the cash flow environment. Once the nonlinearity of CCFS is controlled for, the association between a country’s financial development and CCFS becomes insignificant. The findings highlight that endogenous CCFS reflects a multitude of saving motives and that firms persistently save cash from internal resources regardless of financial market advances. The third paper extends the original interpretation of CCFS. We show that the corporate propensity to save is positively asymmetric. The sensitivity relationship is significantly stronger when a firm faces positive cash flow and remains positive in a negative cash flow environment. We further find that firms with different levels of financing constraints systematically save cash from their cash flows. This finding indicates that a variety of forces, along with information on financing frictions, drive CCFS.