The impact of negative cash flow and influential observations on investment-cash flow sensitivity estimates

Kaplan and Zingales [Quart. J. Econ. 112 (1997) 169] and Clearly [J. Finance 54 (2) (1999) 673] diverge from the large literature on investment-cash flow sensitivity by showing that investment is most sensitive to cash flow for the least financially constrained firms. We examine if this result can be explained by the fact that when firms are in sufficiently bad shape (incurring cash losses), investment cannot respond to cash flow. We find that while Cleary's results can be explained by such negative cash flow observations, the Kaplan-Zingales results are driven more by a few influential observations in a small sample. We also record a decline in investment-cash flow sensitivity over the 1977-1996 period, particularly for the most constrained firms. (C) 2003 Elsevier B.V. All rights reserved.