Firm Investment, Financial Constraint and Voluntary Asset Sales

Abstract

This paper contributes empirically to the ‘Excess Sensitivity’ literature by arguing that results obtained by using investment-cash flow sensitivity as a metric to represent finance constraint of firms can be misleading. This is because cash flow apart from signaling change in net worth may also signal investment opportunities of firms. Following Hovakimian and Titman (2006), we use funds obtained from voluntary asset sales rather than cash flow to represent internal liquidity of firms. Use of funds obtained from voluntary asset sales is justified as it is unlikely to be related to the firm’s future investment opportunities unless they are financially constrained. We study private Indian manufacturing firms in the period 1994 to 2009 for the exercise. We take care of the endogeneity and the implicit monotonicity problems, which are much debated in the literature, by using an endogenous regime switching model.