An Analytic Framework For Interpreting Investment Regressions In The Presence Of Financial Constraints
A financial constraint that prevents access to external funds induces non-classical measurement error in average q as a proxy for unobservable marginal q. Unlike classical measurement error, this measurement error biases upward the coefficient on average q in a univariate regression of investment on average q. In a multiple regression of investment on average q and cash flow, the coefficient on cash flow is positive. The positive cash-flow coefficient indicates the presence of a financial constraint, but it does not indicate a shortage of liquidity to fund current investment. In addition, the coefficient on average q is biased downward.
Previous versions circulated as ”The Impact of Financial Constraints on Investment, Dividends, and q.” We thank participants in seminars at the Federal Reserve Banks of Atlanta and St. Louis and the Penn Macro Lunch Group for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.