The Impact of Cash Flow Uncertainty on Investment-Cash Flow Sensitivity in China : The Debt Financing Channel

The investment-cash flow sensitivity (ICFS) of Chinese firms declined during the global financial crisis, which contradicts the conventional financial constraint interpretation of ICFS. We analyze this phenomenon by examining how cash flow uncertainty affects the ways of financing investment. We find that ICFS reveals not only the relationship between investment and cash flow but also the one between internal funds and debt financing. When internal funds and debt financing are complementary, cash flow uncertainty decreases ICFS more than when internal funds and debt financing are substitutes. The relationship between internal funds and debt financing weakens when cash flow uncertainty rises. A natural experiment based on the global financial crisis (GFC) and the post-GFC economic stimulus package assures that relationship between cash flow uncertainty and ICFS is causal