ASYMMETRIC INFORMATION, LIQUIDITY CONSTRAINTS, AND CANADIAN INVESTMENT

A new theoretical literature has suggested that the Modigliani-Miller Theorem may not hold under imperfect information and that liquidity may affect a firm's investment spending. This paper provides three original tests for such capital market imperfections, based on predicted differences in investment between firms in different informational positions with respect to potential creditors or investors. The empirical tests suggest that information asymmetries have a large effect on investment behaviour. The form of the tests reduces the likelihood of biases due to problems of endogeneity. The paper also examines the effect of differential measurement error on the tests.