The impact of capital market imperfections on capital and R&D Investment and financial decisions

The aim of this study is to provide more insights into our understanding of several issues pertaining to the evolution of a firms’ investment – cash flow sensitivity (ICFS hereafter), the evolution of a firms’ research and development (R&D) ICFS and the determinants of a firms’ R&D investment over total investment1 (R&D/TINV) ratio. This thesis uses non-financial US and UK publicly listed firms. Our work consists of a number of important and original aspects that potentially contribute to the literature on capital market imperfections.The study of the ICFS comprises one of the largest literatures in corporate finance, yet little is known about the ICFS trend over time, and the literature has largely ignored that firms invest simultaneously in two types of investment (capital and R&D) and there is some substitutability between them, thus the two decisions need to be studied together.Initially we show that over time the ICFS: (i) declines for physical investment, (ii) is negative and increases for R&D, and (iii) is negative and fluctuates around the same level during the pre-crisis period and positive during the financial crisis period for R&D/TINV ratio. We argue that these findings can largely be explained by the changing composition of investment and the rising share of the firms with persistent negative cash flows. Secondly, substantial differences are found between the a priori subsamples of financially constrained and unconstrained group of firms and between US and UK firms as well as between pre-crisis and financial crisis periods