Corporate efficiency, credit status and investment

This paper considers the relationship between financial frictions and investment. In an effort to clarify the role of cash flow in examining the impact of capital-market imperfections, endogenous switching regression models (SRM) are estimated for a panel of 1122 UK firms listed on the London Stock Exchange over the period of 1981 to 2009. Not only is the financial regime which the firm faces endogenous, we also allow the regime to change over time via modelling efficiency using stochastic frontier analysis. The results reveal that a firm’s constrained credit status changes with the improvement of its efficiency. Furthermore, the analysis reveals that financially constrained firm’s investment is comparatively more sensitive to its cash flow. Moreover this sensitivity is statistically significant and is negatively related with corporate efficiency.