Investment-cash flow sensitivity measures investment thirst, but not financial constraint

Literature streams disagree about the capacity of investment-cash flow sensitivity (ICFS) to measure both investment thirst and financial constraint. We argue that ICFS measures the former but not the latter. Therefore, we use Fazzari etal.'s study (1988) to develop a model to test the relationship between ICFS and financial constraint, but extend that model using Kornai (1979) to include investment thirst. We demonstrate: because the ICFS-financial constraint relationship varies, ICFS cannot measure financial constraint. Conversely, using a natural experiment of China's Four Trillion Stimulus policy, we show ICFS significantly and positively correlates with investment thirst after controlling for financial constraint.