Abstract
This paper investigates the significance of internal finance in determining firms' fixed capital investments. We estimate an investment model which allows us to test whether the marginal impact of cash flows on investment varies with the central bank's monetary policy stance, financial conditions at the macro level and the Global Financial Crisis (GFC). Using a comprehensive panel data set of Turkish small and medium-sized enterprises (SMEs) in the manufacturing sector, we find that investment-cash flow sensitivity is positive and statistically significant. This result implies that Turkish firms are financially constrained by internal finance. Results suggest that the monetary policy stance, represented by various indicators for robustness, significantly affects firms' financing constraints. In particular, investment-cash flow sensitivity declines during expansionary monetary policy periods. However, the argument does not hold for financially less constrained firms which can access external finance relatively easily. Having examined the response of firms' financing constraints to changes in financial conditions, we find that the investment-cash flow sensitivity declines when financial conditions are relatively supportive. Finally, firms need cash flow more for investing in the GFC compared to other years. The finding is consistent with relatively less availability of external funds in crisis periods.