The impact of cash flow volatility on discretionary investment and the costs of debt and equity financing

We show that higher cash flow volatility is associated with lower average l evels of investment in capital expenditures, R&D, and advertising. This ass ociation suggests that firms do not use external capital markets to fully c over cash flow shortfalls but rather permanently forgo investment. Cash flo w volatility also is associated with higher costs of accessing external cap ital, Moreover, these higher costs, as measured by some proxies, imply a gr eater sensitivity of investment to cash flow volatility. Thus, cash flow vo latility not only increases the likelihood that a firm will need to access capital markets, it also increases the costs of doing so. (C) 1999 Elsevier Science S.A. All rights reserved. JEL classification: G31.