Are Financial Constraints an Important Determination in a Firm's Behavior

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The Cash Flow Sensitivity of Sash
Research Question Does the link between financial constraints and firms demand for liquidity can help us identify whether financial constraints are an important determinant of firm behavior. Contribution Previous scholars, Fazzari, Hubbard, and Petersen, proposed that investment activities of a firm is limited by the firm’s financial situation, which is called financial constraints. When firms face financial constraints, the firm’s investment-cash flow sensitivity is high. When a firm face no financial constraints, its investment-cash flow sensitivity is low. However this theory was doubtful by some scholars. In 1997, Kaplan and Zingales propose an exactly opposite theory. In 2001,
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The authors further test the intuition of our argument by investigating firms’ propensity to save cash out of cash inflow over the business cycle.


The authors use two alternative method to empirically model the cash flow sensitivity of cash. The first model only include proxies: cash flow and investment opportunities. The second model is estimated from a method in which a firm’s decision to change its cash holdings is modeled as a function of a number of sources and uses of funds. The result reported in table III is related to the first model. The set of constrained firms shows significantly positive sensitivities of cash to cash flow sensitivities. The sensitivity estimates for constrained firms are between 0.051 and 0.062 and are all statistically significant at better than the 1% level.

The result reported in table IV is related to the second model. This finding is consistent with the view that there are systematic difference between constrained and unconstrained firms in the way they conduct their cash policies.

Paper’s Findings

By conducting this study, the authors conclude that financial constraints and firm’s liquidity demand can help identify whether financial constraints can
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