The impact of liquidity crises on cash flow sensitivities

• Published in: The Quarterly review of economics and finance 2017-11, Vol.66, p.225-239
• Main Authors: Drobetz, Wolfgang, Haller, Rebekka, Meier, Iwan, Tarhan, Vefa
• Format: Article
• Language: English
• Subjects: Cash flow sensitivity; Financial constraints; Investment spending; Liquidity crises; Supply side shock
• ISSN: 1062-9769; 1878-4259
• DOI: 10.1016/j.qref.2017.03.004

•We examine the relationship between liquidity crises and frictions in raising funds.•We use a multi-equation model of cash flow sensitivities.•Moderate liquidity crises mostly affect firms’ financing activities.•Financially weak firms curtailed both their investment and financing decisions during the recent financial crisis.•Financially healthy firms were able to protect their investments by maintaining financial flexibility. We examine the relationship between liquidity crises and frictions in raising funds, and find that both the gap between the cash flow sensitivities of financially healthy and weak firms and the cash flow sensitivities of healthy and weak firms themselves are positively correlated with the severity of liquidity crises. Using a multi-equation model of cash flow sensitivities, we find that moderate liquidity crises mostly affect firms’ financing activities. The recent financial crisis was especially severe for financially weak firms and curtailed both their investment and financing decisions. Financially healthy firms were able to protect their investments by maintaining financial flexibility.