Abstract
This study examines the impact of financial development on corporate investment in terms of their influence on financing constraints. This study also tries to find the effect of financial development on the investment-cash flow sensitivity across the size, degree of financial constraints and group affiliation of the firm. This study employs dynamic panel data model or more specifically system generalized method of moments (GMM) estimation technique. The estimation results reveal that cash flow affects the investment decision of the company positively, which implies that Indian firms are financially constrained. Also, we observe that financial development reduces the investment-cash flow sensitivity and the effect of financial development is more prominent for small size and standalone firms. The results are robust across the period and, for both financially constrained and unconstrained firms. This study contributes to the existing literature by analyzing the impact of financial development on the role of cash flow in determining investments undertaken by the Indian firms, which is an unexplored issue from an emerging market perspective.
Highlights
Pertinent to the pervasive importance of corporate investment in the growth process of the firm, over the years, the research on the identification of the factors affecting the corporate investment has grown by many folds
The significant positive coefficient of cash flow found from our estimation results in both the investments models implies the presence of financing constraints for Indian firms
The empirical findings of this paper suggest that financial sector development decreases the role of internal cash flow in determining the investment undertaken by the firm
Summary
Pertinent to the pervasive importance of corporate investment in the growth process of the firm, over the years, the research on the identification of the factors affecting the corporate investment has grown by many folds. We try to test whether the effect of financial development on the investment cash flow sensitivity depends on the size of the firm by estimating the following equation: it 1⁄4 α þ β1 I it−1 þ β2Qit. Where, BIG is a dummy variable whose value is 1 for big firms and zero otherwise. As business group affiliation is a very important issue in the context of Indian corporate sector we estimate another equation specified below to investigate whether affiliation to a business group affects the impact of financial development on the investment-cash flow sensitivity. Further considering the effect of firm size and group affiliation on investment-cash flow sensitivity and the individual effect of financial development on corporate investment in the Euler’s equation we specify following four eqs. Wald test is used to test the joint significance of the estimated coefficients for all the variables
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