|Publication||Cash flow sensitivities during financial crises|
University of Hamburg, HEC Montreal, Loyola University
Investment cash flow sensitivity, financial constraints, investment spending, supply-side shock
Using a system of equations model, we analyze whether cash flow sensitivities vary with the economic environment. While the conditions for raising external funds were relatively easy during normal times, even financially healthy firms substituted short-term for long-term borrowing to bridge their financing needs during the pre-2007 liquidity crises. Financially weak firms had restricted access to both short-term and long-term debt markets. They reacted to the earlier crises by issuing more equity and drawing heavily on their cash balances, but cutting their capital expenditures only moderately. These effects became particularly severe during the recent financial crisis of 2007-2009, when raising external funds was extremely difficult. Financially weak firms were forced to cut their investments substantially, implying that their investment-cash flow sensitivities dominate the combined financing- and distribution-cash flow sensitivities.