The impact of liquidity crises on cash flow sensitivities

Abstract

We examine the relationship between liquidity crises and frictions in raising funds, and find that both the gap between the cash flow sensitivities of financially healthy and weak firms and the cash flow sensitivities of healthy and weak firms themselves are positively correlated with the severity of liquidity crises. Using a multi-equation model of cash flow sensitivities, we find that moderate liquidity crises mostly affect firms’ financing activities. The recent financial crisis was especially severe for financially weak firms and curtailed both their investment and financing decisions. Financially healthy firms were able to protect their investments by maintaining financial flexibility. © 2017 Board of Trustees of the University of Illinois