Abstract
The present study aimed to document the effects of financial constraints on the negative relationship between cash flow and external funds, a phenomenon associated with the Pecking Order Theory. This theory suggests that companies subject to more expensive external funds (financially constrained firms) should demonstrate a stronger negative relationship with cash flow than companies subject to minor financial frictions (financially unconstrained firms). The results indicate that the external funds of constrained firms consistently present less negative sensitivity to cash flow compared with those of unconstrained companies. Additionally, the internal funds of constrained companies demonstrate a positive sensitivity to cash flow, whereas those of unconstrained companies do not show any such significant behavior. These results are in accordance with the findings of Almeida and Campello (2010), who suggest the following: first, because of the endogenous nature of investment decisions in constrained companies, the complementary relationship between internal and external funds prevails over the substitutive effects suggested by the Pecking Order Theory; and second, the negative relationship between cash flow and external funds cannot be interpreted as evidence of costly external funds and therefore does not corroborate the Pecking Order Theory.
Highlights
The literature on capital structure has treated investments as exogenous to financial policies (Fama and French, 2002; Shyam-Sunder and Myers, 1999)
The gap addressed in the present study shows the need to reconcile capital structure theories with the endogenous investment implications arising from financial constraints in emerging economies such as Brazil
When applied in new collateralizable assets, these new external funds establish a systematic behavior that amplifies the positive effect of internal funds on the capacity to raise external funds (Almeida and Campello, 2007) by reducing the costs of external funds (Bernanke and Gertler, 1989) and increasing their collateral value (Kiyotaki and Moore, 1997)
Summary
The literature on capital structure has treated investments as exogenous to financial policies (Fama and French, 2002; Shyam-Sunder and Myers, 1999). The authors present evidence that a reduction in the demand for external funds is less sensitive to the internal generation of funds in constrained companies (i.e., is subject to greater financial frictions). This finding contradicts the Pecking Order Theory and suggests that this behavior is associated with the complementarity between external and internal funds because of the effect of endogenous investment. The study aimed to evaluate empirically whether the relationship between the generation of internal funds and the demand for external funds is more negative for financially unconstrained firms than for constrained firms and whether such behavior is associated with the endogenous nature of investments under financial constraints. The present study is structured as follows: section 2 presents the literature review; section 3 presents the methodological aspects; section 4 analyzes the results of empirical testing; and section 5 presents the final considerations
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
