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Can Capital Adjustment Costs Explain the Decline in Investment–Cash Flow Sensitivity?

Published online by Cambridge University Press:  11 April 2023

Shushu Liao ,
Ingmar Nolte  and
Grzegorz Pawlina Open the ORCID record for Grzegorz Pawlina [Opens in a new window]
Shushu Liao
Affiliation:
Kühne Logistics University Department of Leadership and Management Shushu.Liao@the-klu.org
Ingmar Nolte
Affiliation:
Lancaster University Management School i.nolte@lancaster.ac.uk
Grzegorz Pawlina*
Affiliation:
Lancaster University Management School
*
g.pawlina@lancaster.ac.uk (corresponding author)
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Abstract

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It is well documented that since at least the 1970s investment-cash flow (I-CF) sensitivity has been decreasing over time to disappear almost completely by the late 2000s. Based on a neoclassical investment model with costly external financing, we show that this pattern can be explained by the gradual increase of capital adjustment costs, attributable to the accumulation of knowledge capital. The result is robust to a variety of approaches, including Euler equation estimation and the simulated method of moments. More generally, our findings demonstrate that I-CF sensitivity should only be interpreted as a joint measure of financial and real frictions.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 5 , August 2024 , pp. 2399 - 2424
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank Nathalie Moyen (the referee) for her valuable comments and suggestions. We are also grateful to Kevin Aretz, Shantanu Banerjee, Jan Bena, Patricia Boyallian, Aaron Brauner, Sudipto Dasgupta, Daniel Ferreira (discussant), Hans Frimor, Vasso Ioannidou, Paul Malatesta (the editor), Zeynep Onder, Toni Whited, seminar participants at Bilkent University, Università Cattolica del Sacro Cuore, Lancaster University, University of Southern Denmark, the 2017 Annual Corporate Finance Conference, 2017 British Accounting and Finance Association, 2017 World Finance Conference, 2017 KoLa Workshop, and the 2017 NWSSDTP Workshop for helpful comments. Any remaining errors are ours.

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