On the Interaction of Financial Frictions and Fixed Capital Adjustment Costs: Evidence from a Panel of German Firms

This paper analyzes the interaction of financial frictions and non- convex adjustment costs. With non-convex adjustment costs firms infrequently carry out discrete investment projects. Therefore, financial variables may influence investment in two ways. Theoretically, they can alter the frequency at which investment projects are undertaken, or they can influence the size of the stock of capital a company wishes to hold in the long run. Empirically, finance has nearly no long-run influence on the stock of capital in the sample of German companies which this paper analyzes. By contrast, the influence of finance on investment decisions is substantial. Consequently, finance primarily affects investment frequencies and accordingly, financial factors and fundamental capital productivity strongly interact in the determination of investment.