INTERNAL CASH FLOWS AND INVESTMENT DECISIONS: A COMPARATIVE STUDY OF THE U.S. AND JAPAN

Using recent panel data on U.S. and Japanese firms and time-series, cross-sectional analysis, this study documents that in both countries controlling for the investment opportunity set, investments are significantly positively influenced by internal cash flows. This relationship strengthens with the degree of constraints faced in Japan but not in the U.S. Our findings indicate that firms in both countries operate in financially imperfect markets using a pecking order in financing. As expected for Japanese companies, investment by Keiretsu member companies was significantly less influenced by cash flow and more influenced by the investment opportunity set compared to investment by non-member companies.