The Business Cycle, Investor Sentiment, and Costly External Finance

  • Author(s): R. DAVID MCLEAN, MENGXIN ZHAO
  • Published: Mar 19, 2013
  • DOI: 10.1111/jofi.12047

ABSTRACT

The recent financial crisis shows that financial markets can impact the real economy. We investigate whether access to finance typically time‐varies and if so, what are the real effects. Consistent with time‐varying external finance costs, both investment and employment are less sensitive to Tobin's q and more sensitive to cash flow during recessions and low investor sentiment periods. Share issuance plays a bigger role than debt issuance in causing these effects. Alternative tests that do not rely on q and cash flow sensitivities suggest that recessions and low sentiment increase external finance costs, thereby limiting investment and employment.

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