Investment to Cash Flow Sensitivity: Evidence from Manufacturing and Energy Sectors

The persistent decline in investment-cash flow sensitivity (ICFS) in U.S. manufacturing firms has raised questions about what causes ICFS and its decline. We examine ICFS in U.S. and Canadian energy firms which have higher asset tangibility that changes little over time compared to manufacturing firms. We find that ICFS is dominated by investment-cash flow-tangible capital sensitivity and that there is no persistent ICFS decline in the energy sector. We further use two cycles of the oil price boom and bust (2004-2015) as a natural experiment to distinguish between financial constraint and asset tangibility explanations and find that the asset tangibility hypothesis can better explain the findings. Our findings have implications for emerging economies with the oil sector as the main driver of the economy and suggest that fiscal and economic policies could mitigate the adverse effects of these oil price shocks on the economy.