Investment–Cash Flow Sensitivity: Fact or Fiction?

Şenay Ağca and Abon Mozumdar

Journal of Financial and Quantitative Analysis, 2017, vol. 52, issue 3, 1111-1141

Abstract: We examine whether internal funds matter for investment when the measurement error in q is addressed. By carefully employing methodologies that tackle the measurement error in q, we show that cash flow is a significant determinant of investment. We also find that an analyst-forecast-based q measure is not superior to a stock-market-based q measure. We further propose an approach that uses two alternative proxies of q as instruments for addressing measurement error. Our evidence indicates that instrumental-variables-type generalized method of moments estimators yield empirically well-specified models.

Date: 2017
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