Abstract
This study aims to examine the effect of cash flows on investment decision that is moderated by financial constraint and mispricing. The population of the study was all listed-manufacturing firms in Indonesia from 2014 to 2016. Samples were chosen based on the availability of firms’ financial report covering the period of the study. By using moderated regression analysis where financial constraint and mispricing as moderating variables, the study concluded that financial constraint weakens the effect of cash flow on investment. Although lower financially constrained-firms have an opportunity to choose their source of funding, they prefer to finance their investment from an internal source of funding (from cash flows) due to lower risk. Furthermore, mispricing does not have a role as a moderating variable. In this condition, overvalued firms are indifferent from choosing the source of funding. Finally, when financial constraint and mispricing are signed as a moderating variable, they weaken the effect of cash flow on investment. It means that firms with lower financial constraint and overvaluation prefer to use external funding by issuing new common stocks because it provides a lower cost of capital.
Highlights
Investment decision is a central factor in a firm as firm’s value can be maximized if the firm makes an investment
This study aims to examine the effect of cash flows on investment decision that is moderated by financial constraint and mispricing
The regression model was developed to look at the effect of cash flow on investment moderated by financial constraints and mispricing
Summary
Investment decision is a central factor in a firm as firm’s value can be maximized if the firm makes an investment. The assumption of perfect market conditions is not realistic so that there are many studies conducted to examine the association between investment decision and financing decisions under imperfect market conditions. To test whether financing decisions has relation with investment decision, many studies classified firms into two groups; financially constrained firms and financially unconstrained firms (see: Fazzari, Hubbard, and Petersen, 1988; Vogt, 1994; Kaplan and Zingales, 1997; Cleary, 1999; Moyen, 2004, Almeida, Campello, and Weisbach, 2004). By measuring financial constraint as a dummy variable, the researchers compared the impact of internal source of funding measured as cash flow on investment between financiallyunconstrained firms and financially-constrained firms. The intensity of cash flow represents a financing decision that the funding is from the internal firm. There are two contrasting results of empirical tests in the effect of unconstrained-firms’ cash flow on investment and the effect of constrained-firms’ cash flow on investment that will be discussed further below
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