Will Both Direct Financial Development and Indirect Financial Development Mitigate Investment Sensitivity to Cash Flow? The Experience of Taiwan

The Taiwanese government introduced a financial reform plan to encourage financial development. This paper examines this reform strategy to determine whether investment sensitivity to cash flow has actually been reduced. We find that financial development in Taiwan has resulted in improved access to external capital, which reduces firms' reliance on internally generated funds for investment. However, the reduction of investment sensitivity to cash flow is due to indirect financial development (development of financial intermediaries), but not direct financial development (stock market development). After several robustness tests, the main findings remain unchanged.