TY - JOUR AU - Fazzari,Steven AU - Hubbard,R. Glenn AU - Petersen,Bruce C. TI - Financing Constraints and Corporate Investment JF - National Bureau of Economic Research Working Paper Series VL - No. 2387 PY - 1988 Y2 - December 1988 UR - http://www.nber.org/papers/w2387 L1 - http://www.nber.org/papers/w2387.pdf N1 - Author contact info: Steven Fazzari Campus Box 1208 One Brookings Drive Washington University St. Louis, MO 63130 E-Mail: fazz@wueconc.wustl.edu R. Glenn Hubbard Graduate School of Business Columbia University, 101 Uris Hall 3022 Broadway New York, NY 10027 Tel: 212/854-3493 Fax: 212/864-6184 E-Mail: rgh1@columbia.edu, ws2187@columbia.edu Bruce C.. Petersen Economics Department Washington University One Brookings Drive; CB 1208 St. Louis, MO 63130-4899 Tel: 314/889-5643 E-Mail: petersen@artsci.wustl.edu AB - 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. ER -