RDP 2005-12: Financial Constraints, the User Cost of Capital and Corporate Investment in Australia Appendix C: Comparisons with Earlier Australian Studies

The theory that the presence of negative cash flow observations dampens the effect of cash flow on investment may help to reconcile my findings with those of earlier Australian studies, which found greater investment-cash flow sensitivities for constrained firms. These papers generally concentrate on the manufacturing sector, use much smaller samples, exclude delisted companies, and require that firms survive for the full sample period (usually about 10 years). This study excludes only the financial sector, uses a sample at least four times as large as previous studies and includes delisted companies. Hence, the sub-sample of financially constrained firms is more likely to include firms reporting negative cash flow.

As a test of this hypothesis, and to make my data more comparable with the earlier Australian studies, we adjust the sample so that firms must survive for at least 10 years, be either in the consumer discretionary or consumer staples industries (as a proxy for manufacturing) and have non-negative cash flow each year.

Adjusting the sample to be more comparable to the earlier studies, we find the conventional (positive) relationship between cash flow and investment (Table C1). Furthermore, the adjustments significantly boost the effect of both Q and cash flow on investment. However, these adjustments also reduce the size of the sample so these results should be treated with some caution.

Table C1: The Q Model Based on Sample Selection Criteria Used in Earlier Australian Studies
Qi,t−1 0.04***
CFi,t/Ki,t−1 0.34***
Observations 585
Firms 52
Within R2 0.106
Notes: Fixed-effects estimation. Robust standard errors in parentheses. Coefficients on constants are omitted. ***, ** and * denote statistical significance at the 1, 5 and 10 per cent levels respectively.