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

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  • Becker Bo

    (Harvard Business School)

  • Sivadasan Jagadeesh

    (University of Michigan - Ann Arbor)

Abstract

We investigate if financial development eases firm level financing constraints in a cross-country data set covering much of the European economy. The cash flow sensitivity of investment is lower in countries with better-developed financial markets. To deal with potentially serious biases, we employ a difference-in-difference methodology. Subsidiaries of other firms have access to internal capital markets and hence depend less on the external financial environment. As predicted, the benefit of financial development is smaller in subsidiary firms. This shows that financial development can mitigate financial constraints, and sheds light on the link between financial and economic development.

Suggested Citation

  • Becker Bo & Sivadasan Jagadeesh, 2010. "The Effect of Financial Development on the Investment-Cash Flow Relationship: Cross-Country Evidence from Europe," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 10(1), pages 1-49, May.
    • Handle: RePEc:bpj:bejeap:v:10:y:2010:i:1:n:43
    DOI: 10.2202/1935-1682.2302
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    15. Minjia Chen & Alessandra Guariglia, 2011. "Financial constraints and firm productivity in China: do liquidity and export behavior make a difference?," Discussion Papers 11/09, University of Nottingham, GEP.
    16. Zhang, Dongyang & Liu, Deqiang, 2017. "Determinants of the capital structure of Chinese non-listed enterprises: Is TFP efficient?," Economic Systems, Elsevier, vol. 41(2), pages 179-202.
    17. Lashitew, Addisu A., 2017. "The Uneven Effect of Financial Constraints: Size, Public Ownership, and Firm Investment in Ethiopia," World Development, Elsevier, vol. 97(C), pages 178-198.
    18. Mehmet Balcilar & Serhan Çiftçioğlu & Hasan Güngör, 2016. "The Effects Of Financial Development On Investment In Turkey," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(04), pages 1-21, September.
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    20. Lashitew, Addisu A., 2011. "Does Access to Finance Lower Firms’ Cost of Capital? Empirical Evidence from International Manufacturing Data," GGDC Research Memorandum GD-120, Groningen Growth and Development Centre, University of Groningen.

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    More about this item

    Keywords

    corporate investment; financial constraints;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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