The firm’s propensity to save cash out of its internal cash flow has been used to develop a new test for the effects of financial market frictions on firm policies. This paper employs a new, model-based scheme to identify financially constrained firms in the data and applies measurement error-consistent generalized method of moments (GMM) estimators to a large sample of Taiwanese firms. The large discrepancy between the GMM and OLS estimates indicates that the impact of measurement error on inference is substantial. Moreover, both constrained and unconstrained firms display positive cash flow sensitivity of cash, suggesting that Taiwanese managers choose to finance investment with internal cash flow, despite the availability of low cost external funds.
Proceedings of The Third NTU International Conference on Economics, Finance and Accounting, 25pages