Abstract
Capital market imperfection and problems of asymmetric information lead to a difference between the cost of internal and external funds. As a consequence investment by firms facing high information cost is not only determined by expected profitability but also potentially by the availability of internal funds. Investments by those firms expected to face higher information cost are thought to be more constrained by the availability of internal finance and vice versa. Therefore, the present study derives a theoretical investment-liquidity constraint model to test the hypothesis that the investment decisions of more financially constrained firm will be more sensitive to their internal funds as compared to the less financially constrained firms in the case of least developed capital market. The basic idea to this notion underlies various empirical studies on the severity of liquidity constraints for investment. The major findings of the study indicate that when the information asymmetry between firm and investor increases, investment becomes more sensitive to changes in internal funds.
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