What Drives Investment-Cash Flow Sensitivity Around the World?

Abstract

Motivated by ongoing debates on investment-cash flow sensitivity (ICFS) and its documented decline and disappearance in the U.S., we investigate the determinants of ICFS. Using firm-level data across 43 countries for the 1993-2013 period, we document an important role of asset tangibility in explaining the patterns in ICFS. Asset tangibility affects ICFS through two channels: investment intensity and cash flow persistence. As the share of tangible capital, investment and cash flow persistence fell in developed economies, ICFS has declined. In contrast, as developing economies operate with more tangible capital, have higher rates of investment and more persistent cash flow, their ICFS are relatively stable. The results support our explanation of ICFS as a reflection of investment activity and income predictability, rather than a measure of financial constraints.