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The Effect Of Financial Development On The Investment-Cash Flow Relationship: Cross-Country Evidence From Europe

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Executive Summary

The authors investigate if financial development eases firm level financing constraints in a cross-country data set covering much of the European economy. The cash flow sensitivity of investment is lower in countries with better-developed financial markets. To deal with potentially serious biases, they employ a difference-in-difference methodology. Subsidiaries of other firms have access to internal capital markets and hence depend less on the external financial environment. As predicted, the benefit of financial development is smaller in subsidiary firms. This shows that financial development can mitigate financial constraints, and sheds light on the link between financial and economic development.

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