Investment-cash flow sensitivities or cash-cash flow sensitivities? An evaluative framework for measures of financial constraints

We evaluate two models commonly used for measuring financial constraints in their ability to discriminate between constrained and unconstrained firms. We compute firm-specific estimates for the cash flow sensitivity of investment (CFSI), and the cash flow sensitivity of cash (CFSC) and provide a framework that summarizes the performance of each model into a single numerical metric. We argue that this 'ex-post' approach provides interesting advantages over the traditional operationalization, in which firms are classified 'ex-ante' on a theoretical basis. Our findings suggest the superiority of the CFSI model over the CFSC model for a sample of manufacturing SMEs in Belgium.