Do Market Imperfections Give Rise to Financial Constraints? A Growth Type Explanation for the Sensitivity of Investment to Cash Flow

We identify a firm’s growth type by its valuation volatility which proxies for the extent to which asymmetric information arises from growth opportunities rather than from assets-in-place. We show that firm investment style (measured by R&D/[Capex+R&D]) is persistent and positively aligned with growth type. The sensitivity of investment to cash flow has a monotonic negative relationship with growth type. Additionally, the sensitivity of equity-anddebt-financing-differential to market conditions increases with investment style, reflecting a growth-type-aligned pecking order in financing. These findings demonstrate that firms invest and seek financing in a manner compatible with their growth type. This suggests that informational imperfections do not necessarily impose financing constraints on firms listed on well-functioning capital markets.