Liquidity constraints and firms' investment return behaviour

We construct a production-based model, which compares the investment return behaviour of liquidity-constrained firms with that of unconstrained Firms, The key testable implication that emerges from the model is that the investment returns of the constrained Firms are predictable, while those of the unconstrained firms are not. We test this implication indirectly, verifying whether the capital stock and investment returns of the latter firms lead those of the former, and directly, via the estimation of an Euler equation. Our results are consistent with the model's prediction.