Investment–Cash Flow Sensitivity: Fact or Fiction?

Abstract

We examine whether internal funds matter for investment when the measurement error inqis addressed. By carefully employing methodologies that tackle the measurement error inq, we show that cash flow is a significant determinant of investment. We also find that an analyst-forecast-basedqmeasure is not superior to a stock-market-basedqmeasure. We further propose an approach that uses two alternative proxies ofqas instruments for addressing measurement error. Our evidence indicates that instrumental-variables-type generalized method of moments estimators yield empirically well-specified models.