Credit Constraints and Investment-Cash Flow Sensitivities

This paper analyzes the investment behavior of ...rms under a quantity constraint on the amount of external funds which can be raised at a given cost (credit constraints). In this world, investment-cash ‡ow sensitivities decrease in the degree of credit constraints, until a ...rm becomes e¤ectively unconstrained. This generates a “U-shaped” curve for the relationship between sensitivities and credit constraints. From an empirical perspective, the good news is that we suggest a theoretically consistent way to identify the impact of ...nancial constraints on investment behavior, at least under the condition that ...nancial constraints a¤ect primarily the quantity of credit available to ...rms. The bad news is that our prediction is in a sense the opposite as the one explored in previous empirical literature.