Financing Constraints and Corporate Investment

Steven Fazzari, R. Glenn Hubbard, Bruce C. Petersen

NBER Working Paper No. 2387 (Also Reprint No. r1069)
Issued in September 1987
NBER Program(s):   ME   PE

Most empirical models of investment rely on the assumption that firms are able to respond to prices set in centralized securities markets (through the "cost of capital" or "q"). An alternative approach emphasizes the importance of cash flow as a determinant of investment spending, because of a "financing hierarchy," in which internal finance has important cost advantages over external finance. We build on recent research concerning imperfections in markets for equity and debt. This work suggests that some firms do not have sufficient access to external capital markets to enable them to respond to changes in the cost of capital, asset prices, or tax-based investment incentives. To the extent that firms are constrained in their ability to raise funds externally, investment spending may be sensitive to the availability of internal finance. That is, investment may display "excess sensitivity" to movements in cash flow. In this paper, we work within the q theory of investment, and examine the importance of a financing hierarchy created by capital-market imperfections. Using panel data on individual manufacturing firms, we compare the investment behavior of rapidly growing firms that exhaust all of their internal finance with that of mature firms paying dividends. We find that q values remain very high for significant periods of time for firms paying no dividends, relative to those for mature firms. We also find that investment is more sensitive to cash flow for the group of firms that our model implies is most likely to face external finance constraints. These results are consistent with the augmented model we propose, which takes into account different financing regimes for different groups of firms. Some extensions and implications for public policy are discussed at the end.

download in pdf format
   (401 K)

email paper

This paper is available as PDF (401 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w2387

Published: Fazzari, Steven M., R. Glenn Hubbard, and Bruce C. Petersen. "Financing Constraints and Corporate Investment." From Brookings Papers on Economic Activity, Vol. 1, pp. 141-195, (1988). citation courtesy of

Users who downloaded this paper also downloaded these:
Okun The Value of Anticipations Data in Forecasting National Product
Fukao and Ito Foreign Direct Investment and Services Trade: The Case of Japan
Bailey w19493 Fifty Years of Family Planning: New Evidence on the Long-Run Effects of Increasing Access to Contraception
Gentry and Schizer w9243 Frictions and Tax-Motivated Hedging: An Empirical Exploration of Publicly-Traded Exchangeable Securities
Friedman, Johnson, and Mitton w9949 Propping and Tunneling
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us