Time to Build Capital: Revisiting Investment-Cash Flow Sensitivities (extended version)

A large body of empirical work has established the significance of cash flow in explain-ing investment dynamics. This finding is further taken as evidence of capital market imperfections. We show, using a perfect capital markets model, that time-to-build for capital projects creates an investment cash flow sensitivity as found in empiri-cal studies that may not be indicative of capital market frictions. The result is due to mis-specification present in empirical investment-q equations under time-to-build investment. In addition, time aggregation error can give rise to cash flow effects inde-pendently of the time-to-build effect. Importantly, both errors arise independently of potential measurement error in q. Evidence from a large panel of U.K. manufacturing firms confirms the validity of the time-to-build investment channel