Investment-Cash Flow Sensitivities are Useful: A Comment on Kaplan and Zingales

In a recent paper in this Journal Kaplan and Zingales {1997, hereinafter KZ} argue that investment-cash èow sensitivities do not provide useful evidence about the presence of énancing constraints. Because KZ use a subset of the same érms and the same regressions as Fazzari, Hubbard, and Petersen {1988, hereinafter FHP} and claim {page 176} that FHP ''can legitimately be considered the parent of all papers in this literature,'' it is appropriate that we respond. Based on a simple theoretical model, KZ reach the provocative conclusion {page 211} that ''the invest- ment-cash èow sensitivity criterion as a measure of énancial constraints is not well-grounded in theory.'' In Section I we show that the KZ model does not capture the theoretical approach employed in FHP and many subsequent studies. Most of the KZ paper attempts to show that empirical investment-cash èow sensitivities do not increase monotonically with the degree of énancing constraints within the 49 low-dividend érms from the FHP sample. In Section II we explain why the KZ classiécation of the degree of constraints is èawed in identifying both whether or not érms are constrained (absolute constraints) as well as the relative degree of constraints across érms.As a result, we argue in Section III that there is no expected ex ante pattern for the