Abstract
Using Q investment model to scrutinize investment-cash flow sensitivity, a measure of financial constraint, has been a subject of controversy in literature. By using an alternative model called Error Correction model, this study aims to check the sensitivity between firm’s internal finance and investment level for the case of lower middle income country. Literature has shown that firms’ specific characteristics affect the relation between investment and cash flow of the firms. By considering the unique characteristics of Pakistani corporate sector, this study further target to check whether the investment-cash flow sensitivity differs across size of the firms, group affiliation of the firms and dividend policy of the firms. Our findings indicate that Pakistani listed firms are financially constrained. We find a strong relationship between investment and cash flow for small and non-dividend-paying firms; whereas group-affiliation does not affect investment- cash flow sensitivity of firms.
Highlights
Economic growth of every country mainly relies on the investment level
An extensive literature check the impact of financial frictions on firm investment and firm behaviour
We further find that effect of cash flow on investment is not significant for group-affiliated firms
Summary
Economic growth of every country mainly relies on the investment level. Continuous and consistent investment growth is a significant determinant of economic development. The problem may arise if present value of expected future net distribution diverges from the stock market valuation (Cummins et al, 2006). Another challenge to the performance of q theory is given by (Carpenter and Guariglia, 2008) who argued that q model only forecasts outsiders’ assessments of investment opportunities. It does not assess insiders’ estimation of opportunities. We contribute to the prevailing literature by using a different approach such as error correction model (ECM) to see investmentcash flow sensitivity, whereas the previous studies (such as Riaz et al, 2016; Rashid & Jabeen, 2018) have checked this relationship by using Q investment method
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