financial constraints, the user cost of capital and corporate.pdf

FINANCIAL CONSTRAINTS, THE USER COST OF CAPITAL AND CORPORATE INVESTMENT IN AUSTRALIA Gianni La Cava Research Discussion Paper 2005-12 December 2005 Economic Analysis Reserve Bank of Australia The author would like to thank Luci Ellis, James Holloway, Christopher Kent, Tony Richards, Geoffrey Shuetrim, James Vickery, seminar participants at the Reserve Bank of Australia and especially Alex Heath for helpful comments and discussion. The views expressed in this paper are those of the author and do not necessarily reflect the views of the Reserve Bank of Australia. Abstract This paper examines the factors that drive corporate investment in Australia using a panel of listed companies covering the period from 1990 to 2004. Real sales growth is found to be a significant determinant of corporate investment. The user cost of capital, which incorporates both debt and equity financing costs, also appears to be an important determinant. The paper also explores the effects of cash flow on investment, allowing for the possibility that the availability of internal funding could significantly affect the investment of financially constrained firms. Cash flow is found to affect investment, though the effects appear more complicated than previously reported in empirical research using Australian data. One innovation of this study is that it distinguishes financially distressed firms from financially constrained firms. The presence of financially distressed firms appears to bias downwards the sensitivity of investm