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Investment-cash flow sensitivities and capital misallocation

Chanbora Ek and Guiying Laura Wu

Journal of Development Economics, 2018, vol. 133, issue C, 220-230

Abstract: This paper directly estimates the effect of financing constraint on capital misallocation. We provide a simple theoretical framework that links the heterogeneity in investment-cash flow sensitivity, a common indicator of financing constraint, to the dispersion of marginal revenue product of capital, a direct measure of allocative inefficiency. Our model shows that the existence of both constrained and unconstrained firms is a sufficient though not necessary condition for capital misallocation. Empirically, we run an error-correction investment model for U.S. Compustat and Chinese manufacturing firms, and for various sub-samples of the Chinese firms. Our estimates on investment-cash flow sensitivities imply a 5% and 15% total factor productivity loss respectively for the balanced and unbalanced panels of Chinese firms. Our identification strategy does not require any monotonic relationship between investment-cash flow sensitivities and severity of financial frictions, thus is not subject to the Kaplan and Zingales critique.

Keywords: Financial frictions; Investment-cash flow sensitivity; Capital misallocation; Chinese economy (search for similar items in EconPapers)
JEL-codes: D92 E22 G32 O16 O47 (search for similar items in EconPapers)
Date: 2018
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