Essays on corporate investments, learning, and financial constraints

Essay I - Corporate investments and financial constraints. We shed new light on the effect of financial constraints on the sensitivity of a firm's investment to its cash flow by taking into account fixed firm effects when controlling for possible measurement errors in Tobin's q. In contrast to Erickson and Whited (2000), our larger sample allows us to obtain identification of the measurement error consistent GMM estimator with fixed firm effects. Contrary to recent findings that measurement errors in Tobin's q generate spurious sensitivities, we find that investment remains sensitive to cash flow after controlling for measurement errors and fixed firm effects. Both more constrained and less constrained firms, as identified by multivariate indexes of financial constraints, invest more following an increase in cash flow, while economically distressed firms invest less. In fact, we find that the investments of less constrained firms are the most sensitive to cash flow, consistent with recent theoretical predictions.; Essay II - Corporate investments and learning. We investigate how firm age affects the sensitivity of a firm's investment to its cash flow. We also recognize that young firms are widely perceived as more likely to be financially constrained. In this essay we disentangle the effect of firm age from the effect of financial constraints on the sensitivities. Our empirical findings indicate that the investments of younger or less constrained firms are more sensitive to cash flow fluctuations. Measurement errors in Tobin's q do not explain away the cash flow sensitivities. Consistent with recent theoretical predictions, we show that firm age may proxy for learning within a firm, where young firms update their beliefs about the quality of their investment projects by observing cash flow realizations. Perhaps surprisingly, we find that the sensitivity to cash flow is lower for firms operating in younger industries. Firms in young industries have more volatile cash flows. When cash flows are more noisy, their ability to act as an instrument for investment opportunities deteriorates, and the investment-cash flow sensitivity decreases. A neoclassical dynamic investment model augmented with learning replicates our empirical findings. Our evidence suggests that learning may be an important structural force affecting firms' investments.