Why Does Liquidity Matter in Investment Equations?

Why does capital structure choice vary with macroeconomic conditions?

“…BGG also relate the shift in inventory investment away from small (or bank-dependent) firms following a Federal Reserve monetary tightening with the asymmetry in access to capital markets across firms. This is consistent with Chirinko and Schaller(1995), Fazzari, Hubbard and Peterson(1988), Gilchrist and Himmelberg(1995), Hubbard, Kashyap and Whited(1995) and Whited(1992), who present firm level evidence suggesting that cash flows, and therefore access to capital markets, affect investment decisions. 5 As discussed in Korajczyk and Levy (2000), the arguments used to explain cross-sectional variation in capital (1984) setting where privately informed managers have current equity owners interest in mind and avoid issuing equity when they believe their shares are underpriced.…”

“…The liquidation option introduces a lower bound on managers' compensation that is translated to a restriction on leverage. 13 As shown in Proposition 2, securities that result in truth telling and no liquidation dominate securities that result in non-truth telling or liquidation.…”

“…Since payoffs from debt securities are assumed to be independent of the report (Assumption 4), no 13 A manager that is indifferent between liquidating and reporting is assumed to report. A manger that is indifferent between reporting truthfully and falsifying is assumed to report truthfully.…”

The impact of financial constraints on firm survival and growth

“…Chirinko and Schaller (1995) suggest two possible hypotheses: the existence of financial constraints (due to the existence of either asymmetric information or transaction costs), and mere mispecification whereby liquidity takes up the effect of other omitted variables.…”

Markup cyclicality and input factor adjustments

“…Here, returns to scale are in the range 0.89-0.96. dividend restriction can loosely be interpreted as a premium on external funding. Borrowing restrictions may be formulated either as an absolute debt limit or, with interest payments increasing, in a variable which is correlated with the likelihood of facing borrowing constraints (see for instance Meghir, 1994, Chirinko andSchaller, 1995, and for a recent overview Bond and van Reenen, 2007). We have tested for both ways of representing financial frictions.…”