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Finance constraints or free cash flow?

A new look at the life cycle model of the firm

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Abstract

It has long been argued that firms prefer internal to external finance for funding investment. Modern literatures in industrial organization, macroeconomics, and finance argue this preference is caused by information asymmetries. There are, however, important disagreements about the effect of the asymmetries. Asymmetries may lead to binding financing constraints, or they may allow managers to use free cash flow for unprofitable projects. Each model predicts a different relationship between investment and changes in debt finance and this paper estimates this relationship using firm-level data. The principal findings are that both financing constraints and the agency costs of free cash flow affect investment in a manner consistent with a life cycle model of the firm.

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Authors and Affiliations

  1. Department of Economics, Emory University, Atlanta, USA

    Robert E. Carpenter

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  1. Robert E. Carpenter
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Carpenter, R.E. Finance constraints or free cash flow?. Empirica 22, 185–209 (1995). https://doi.org/10.1007/BF01384150

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  • DOI: https://doi.org/10.1007/BF01384150

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