Effects of financial constraints and managerial overconfidence on investment-cash flow sensitivity

Abstract

This study primarily explores the interactive effects of financial constraints and managerial overconfidence on the sensitivity of investment-cash flow using a sample of Taiwan non-financial publicly traded firms from 2005 to 2019. We contribute to the literature of financial constraints and managerial overconfidence by using cash-based and interest-based measures to identify financial constraints and adopting stock-based and firm-based measures to classify overconfidence behavior. The results reveal that financial constraints and managerial overconfidence lead to increased investment-cash flow sensitivity. Furthermore, we also investigate the cash flow effect on overinvestment inefficiency and address endogeneity concerns in our regression models. The findings show that firms with managerial overconfidence are more prone to exhibit overinvestment when internal cash flow is sufficient, and the impact is stronger for financially constrained firms. Our evidence suggests that financing constraints, managerial overconfidence, and free-cash-flows problem all play a vital role in corporate investment decisions.