Time to Build Capital: Revisiting Investment-Cashflow Sensitivities

John Tsoukalas ()

Discussion Papers from University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM)

Abstract: Is cash flow important in explaining investment dynamics? A large body of empirical work argues that it is. This finding is further taken as evidence of capital market imperfections. We argue that time-to-build for capital projects creates an investment cash flow sensitivity as found in empirical studies that may not be indicative of capital market frictions. We demonstrate this using a perfect capital markets model with firms that make investment decisions in capital projects indexed by the length of the time-to-build. We show that the typical (empirical) investment regression with q and cash flow is ridden with specification error under time-to-build investment. This error is due to an omitted right hand side state variable (current expenditure on existing capital projects) that fully describes optimal investment along with marginal q and is strongly correlated with cash flow. In addition, time aggregation error can give rise to cash flow effects independently of the time-to-build effect. Importantly, both errors arise independently of potential measurement error in q.

Keywords: Investment; Capital market imperfections; Time-to-build. (search for similar items in EconPapers)
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http://www.nottingham.ac.uk/cfcm/documents/papers/09-05.pdf (application/pdf)

Related works:
Journal Article: Time to build capital: Revisiting investment-cash-flow sensitivities (2011)
Working Paper: Time to Build Capital: Revisiting Investment-Cash Flow Sensitivities (2009)
Working Paper: Time to Build Capital: Revisiting Investment-Cash Flow Sensitivities (2009)
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Persistent link: http://EconPapers.repec.org/RePEc:not:notcfc:09/05

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