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Why Did the Investment–Cash Flow Sensitivity Decline over Time?

Published online by Cambridge University Press:  04 August 2020

Zhen Wang  and
Chu Zhang Open the ORCID record for Chu Zhang [Opens in a new window]
Zhen Wang
Affiliation:
Shanghai University SILC Business Schoolwang_zhen@shu.edu.cn
Chu Zhang*
Affiliation:
Hong Kong University of Science and Technology
*
czhang@ust.hk (corresponding author)
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Abstract

We propose an explanation for why corporate investment used to be sensitive to cash flow and why the sensitivity declined over time. The sensitivity stems from the informational role of cash flow in inferring the productivity of tangible capital in the old economy. Over time, however, more new-economy firms enter the market. These firms have reduced tangible capital productivity and reduced cash-flow predictability, which drives the decline in the average investment–cash flow sensitivity. Theoretical and empirical analyses support this explanation.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 6 , September 2021 , pp. 2272 - 2308
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

We thank Huafeng Jason Chen (the referee) and Jarrad Harford (the editor) for detailed comments that significantly improved the quality of the article. We also thank Heitor Almeida, Hursit Selcuk Celil, Sudipto Dasgupta, Ioannis Floros, Erasmo Giambona, Mark Huson, Heim Kedar-Levy, Yelena Larkin, Laura X. Liu, David McLean, Randall Morck, Vikas Mehrotra, Lilian Ng, Jacob Oded, Jiaping Qiu, and Margret Zhu and seminar/conference participants at the 2014 Asian Finance Association Annual Meeting, the 2014 China International Conference in Finance, the University of Amsterdam, Australian National University, Ben-Gurion University, Chuo University, Deakin University, Fordham University, Lancaster University, Macau University, Manchester University, Queen Mary University of London, Queensland University of Technology, Southern University of Science and Technology (China), Shanghai University, Tel Aviv University, University of Sydney, and York University for helpful comments on an earlier version. All remaining errors are ours.

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