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Can Capital Adjustment Costs Explain the Decline in Investment-Cash Flow Sensitivity?

Research output: Contribution to Journal/MagazineJournal articlepeer-review

E-pub ahead of print
<mark>Journal publication date</mark>11/04/2023
<mark>Journal</mark>Journal of Financial and Quantitative Analysis
Number of pages48
Publication StatusE-pub ahead of print
Early online date11/04/23
<mark>Original language</mark>English


It is well documented that since at least the 1970s investment-cash flow (I-CF) sensitivity has been decreasing over time to disappear almost completely by the late 2000s. Based on a neoclassical investment model with costly external financing, we show that this pattern can be explained by the gradual increase of capital adjustment costs, attributable to the accumulation of knowledge capital. The result is robust to a variety of approaches, including Euler equation estimation and the simulated method of moments. More generally, our findings demonstrate that I-CF sensitivity should only be interpreted as a joint measure of financial and real frictions.