for group firms with bank ties. However, the sign of the same two parameters is negative for this category of companies. This would indicate that an increase in the
stock of liquid assets relaxes the constraint on external finance. Such result is consistent with the literature associating higher debt levels to poor financial health,
but inconsistent with the fact that the same firms also accept the model without a credit limit.
6. The role of liquid assets as a measure of asymmetric information problems
6
.
1
. Limitations of the cash flow 6ariable While Q models provide a straightforward way of including finance constraints,
they also suffer from endogeneity problems. The coefficient of the cash flow variable may be biased because it also proxies for the profitability of investment.
Gilchrist and Himmelberg 1995 try to eliminate this problem by constructing a better proxy for Q. After controlling for future investment opportunities, they find
that cash flow still plays a significant role for companies with poor access to debt markets. However, Kaplan and Zingales 1997 question the use of investment-cash
flow sensitivities as a monotonic measure of financing constraints. By reexamining the results of Fazzari et al. 1988, they argue that firms a priori classified as less
financially constrained are in fact the ones exhibiting greater investment – cash flow sensitivity. The results presented in this paper also suggest that the use of cash flow
does not reflect poor corporate access to external funds. French industrial groups trading on the largest stock exchange are also sensitive to flows of funds. Further,
Euler equation models used in Section 5 do not respond to the use of cash flow as a measure of borrowing constraints.
6
.
2
. Accumulation of liquid assets as a measure of financing constraints Financially constrained firms can offset the impact of cash flow shocks on
investment by adjusting their stock of liquid assets. Fazzari and Peteresen 1993 argue that firms try to smooth investment in the short run in order to avoid rising
adjustment costs in the long run. Because investment in working capital is re- versible, it can be used as a source of internal funds instead of competing with fixed
investment for the use of a limited pool of finance.
The results presented in this paper confirm that only a priori constrained firms base their investment decisions on the availability of working capital and other
liquid assets. Problems of asymmetric information seem to be the main source of financing constraints for these firms. They do not have institutional shareholders to
provide external capital. Further, they are traded on smaller and more recent stock markets. In contrast, well-established industrial groups use Q and cash flow as
determinants of their investment decisions. This suggests that flows of funds, rather than stocks of liquid assets, may measure agency conflicts in large structures.
Managers make sub-optimal investments based on the availability of free cash-flow.
In their international study, Kadapakkam et al. 1998 confirm these findings by showing that large firms rely more on cash flow than small firms.
7. Conclusion
