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Firm Investment and Financial Frictions

Christopher Baum (), Mustafa Caglayan () and Oleksandr Talavera

No 634, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: In this paper we investigate the analytical and empirical linkages between firms' capital investment behavior and financial frictions arising from asymmetric information, proxied by firms' liquidity and degree of uncertainty. Measures of intrinsic and extrinsic uncertainty are derived from firms' daily stock returns and S&P 500 index returns along with a CAPM-based risk measure. We employ a panel of U.S. manufacturing firm data obtained from COMPUSTAT over the 1984-2003 period. Financial frictions captured by interactions between firms' cash flow and both intrinsic and CAPM-based measures of uncertainty have a significant negative impact on firms' investment spending, while extrinsic uncertainty has a positive impact.

Keywords: capital investment; asymmetric information; financial frictions; uncertainty; CAPM (search for similar items in EconPapers)
JEL-codes: E22 D81 C23 (search for similar items in EconPapers)
Pages: 24 p.
Date: 2006
New Economics Papers: this item is included in nep-bec, nep-cse and nep-mac
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