The Effect of Financial Development on the Investment Cash Flow Relationship: Cross-Country Evidence from Europe

43 Pages Posted: 9 Nov 2006

See all articles by Bo Becker

Bo Becker

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); ECGI

Jagadeesh Sivadasan

University of Michigan, Stephen M. Ross School of Business; University of Michigan at Ann Arbor - Survey Research Center

Date Written: October 2006

Abstract

We investigate financing constraints in a large cross-country data set covering most of the European economy. Firm level investment sensitivity to cash flow is used to identify financing constraints. We find that the sensitivities are significantly positive on average, controlling for country and industry fixed effects, as well as firm level controls. Most importantly, the cash flow sensitivity of investment is lower in countries with better-developed financial markets. This suggests that financial development may mitigate financial constraints. This effect is weaker in conglomerate subsidiaries, which are likely to have access to internal capital markets and depend less on the outside financial environment, and possibly for firms in industries with highly liquid assets as well. This result sheds light on the link between financial and economic development.

Keywords: Financial Constraints, Investment, Europe, Financial Development

JEL Classification: E22, E44, G31, L10

Suggested Citation

Becker, Bo and Sivadasan, Jagadeesh, The Effect of Financial Development on the Investment Cash Flow Relationship: Cross-Country Evidence from Europe (October 2006). ECB Working Paper No. 689, Available at SSRN: https://ssrn.com/abstract=936949

Bo Becker (Contact Author)

Stockholm School of Economics ( email )

Drottninggatan 98
Dept. of Finance
111 60 Stockholm, 11160
Sweden

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

ECGI ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Jagadeesh Sivadasan

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

University of Michigan at Ann Arbor - Survey Research Center ( email )

Ann Arbor, MI
United States

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