The study of the investment-cash flow (ICF) sensitivity constitutes one of the largest literatures in corporate finance, yet little is known about changes in the ICF relationship over time, and the literature has largely ignored how rising R&D investment and developments in equity markets have impacted ICF sensitivity estimates. We show that for the time period 1970–2006, the ICF sensitivity: (i) largely disappears for physical investment, (ii) remains comparatively strong for R&D, and (iii) declines, but does not disappear, for total investment. We argue that these findings can largely be explained by the changing composition of investment and the rising importance of public equity as a source of funds, particularly for firms with persistent negative cash flows.

The financing of R&D provides a potentially important channel to link finance and economic growth, but there is no direct evidence that financial effects are large enough to impact aggregate R&D. U.S. firms finance R&D from volatile sources: cash flow and stock issues. We estimate dynamic R&D models for high‐tech firms and find significant effects of cash flow and external equity for young, but not mature, firms. The financial coefficients for young firms are large enough that finance supply shifts can explain most of the dramatic 1990s R&D boom, which implies a significant connection between finance, innovation, and growth.