Knut Wicksell Working Paper Series,
Lund University, Knut Wicksell Centre for Financial Studies

Abstract: In the mid 2000s the oil and gas industry was hit by what might be best described as a ‘wall of cash’ as oil prices successively reached new record levels and access to external financing improved greatly. In this article we investigate what this sudden abundance of liquidity implied for the investment-cash flow relationship, the interpretation of which continues to generate controversy in the financing constraints-literature. For small and financially constrained firms the investment-cash flow sensitivity decreases in the abundance period (2005-2008), suggesting that these firms became less financially constrained in this period. For large and financially unconstrained firms, however, the investment-cash flow sensitivity increases over time, suggesting that this relationship is driven by agency problems related to free cash flow. Our analysis illustrates the importance of a research design that addresses both these competing explanations of the investment-cash flow relationship.

Keywords: Corporate investment; financing constraints; agency costs; investment-cash flow sensitivity

JEL-codes: G30; G32

27 pages, October 9, 2013

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