Abstract：We develop a dynamic model of investment with moral hazard and provide a micro-foundation for financing constraints. In the model, standard inv estmentcash-flow sensitivity regressions will find a small coefficient on Tobin’s Q and a large and significant coefficient on cash flow. Our calibration replicates the empirical fact that larger and more mature firms are less financially constrained but have higher investment-cash-flow sensitivity. Our theory therefore resolves the long-standing puzzle of the existence of the investment-cash-flow sensitivity and the seemingly weak relationship between investment-cash-flow sensitivity and the severity of financing constraints documented by Kaplan and Zingales (1997) and many others.

Key Words: Financing constraints; Dynamic moral hazard; Q theory; Investmentcash-flow sensitivity.

http://www.aeconf.com/Articles/May2024/aef250105.pdf