Journal of Financial and Quantitative Analysis

Research Articles

Where Did All the Dollars Go? The Effect of Cash Flows on Capital and Asset Structure

Sudipto Dasguptaa1, Thomas H. Noea2 and Zhen Wanga3

a1 Department of Finance, Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong,

a2 Said Business School and Balliol College, University of Oxford, Park End St., Oxford OX1 1HP, UK,

a3 School of Finance, Shanghai University of Finance and Economics, 777 Guoding Rd., Shanghai, China,


This paper documents the short- and long-term balance sheet effect of cash flows. We show that cash savings in the short run and debt reduction in both the short and the long run account for a substantial fraction of cash flow use. Although, in the long run, investment exhibits substantial sensitivity to cash flows, investment does not absorb the entire cash flow shock. In fact, the tighter the financial constraints, the smaller the fraction of cash flow absorbed by investment and the more by leverage reduction. Firms stage their response to increases in cash flow, delaying investment while building up cash stocks and reducing leverage. These results suggest that much of the short-run economic effect of cash flow shocks to the corporate sector may be channeled into the corporate debt market rather than the capital goods market, especially when financing constraints tighten.

(Online publication June 29 2011)


We thank Ilona Babenko, Glenn Boyle, Xin Chang, Jarrad Harford, Mike Lemmon, Laura Liu, Paul Malatesta (the editor), Ryo Okui, Paul Povel (the referee), Mungo Wilson, and seminar participants at the Australian National University, City University of Hong Kong, Hong Kong University of Science and Technology, Nanyang Technological University, Singapore Management University, and University of Hong Kong, as well as participants at the 7th Summer Finance Symposium at Said Business School, Oxford University, and at the Conference on Corporate Capital Structure, Liquidity, and Governance at the London School of Economics for helpful comments. Dasgupta gratefully acknowledges financial support from the Research Grants Council of Hong Kong under grant number HKUST6499/06H. Wang acknowledges financial support from the National Natural Science Foundation of China under the grant number 71102135, and the project title “The Single Period and Multi-Period Cash Flow Sensitivities of Chinese Listed Firms.” Errors are our responsibility.