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Investment, default propensity score and cash flow sensitivity in six EU member states: evidence based on firm-level panel data

ABSTRACT Using a panel data set covering six European countries and firms ( observations) over the period –, we analyse the cash flow sensitivity of investment spending. As most of the firms are not listed at stock exchanges, a balance sheet-based approximation on Tobin’s Q is used to indicate investment opportunities. We analyse internal and external liquidity constraints and their effect on investment decisions. In the literature, external constraints are most often indicated by simple accounting-based items/ratios. As the adequacy of the a priori indicator, reflecting the external constraints, is crucial, we contribute in proposing a more sophisticated approach. We estimate propensities to default using adapted random forests. In our descriptive analysis, we find strong evidence for the u-shape of the investment curve. However, after controlling for investment opportunities we find no increased cash flow sensitivity of investment, neither for a priori externally nor for internally constrained firms. Hence, our results hint for the absence of liquidity constraints. We attribute these towards the rather expansionary monetary policy since the financial crisis.