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No. 862: Sample separation and the sensitivity of investment to cash flow: Is the monotonicity condition empirically satisfied?

Alfonsina Iona , Queen Mary University of London
Leone Leonida , King’s Business School, King’s College London

July 5, 2018

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Abstract

This paper studies whether the monotonicity condition of the investment-cash flow sensitivity is satisfied empirically. We show that if this condition holds, then the point of sample separation does not affect the monotonic relationship between the sensitivities of any two complementary classes of observations. Our test, based upon observable averages of the investment-cash flow sensitivity, rejects the monotonicity condition for any common metric of financing constraints we use. The testing procedure we propose reconciles the conflicting findings of the literature about the shape of the investment-cash flow sensitivity.

J.E.L classification codes: G30, G32

Keywords:Investment-cash flow sensitivity, Monotonicity condition, Sample separation

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