Abstract
In the literature, positive investment cash flow sensitivity is attributed to either asymmetric information induced financing constraints or the agency costs of free cash flow. Using data from a sample of 68 manufacturing firms listed on the South African JSE, this paper contributes to the literature by investigating the source of investment cash flow sensitivity. We have found that asymmetric information explains the positive investment cash flow sensitivity better than agency costs. Furthermore, asymmetric information has been observed to be more pronounced in low-dividend-paying firms and small firms. Despite South Africa’s having a developed financial system by international standards, small firms are seen to be financially constrained. We attribute the absence of investment cash flow sensitivity due to agency costs to good corporate governance of South African listed firms. Thus the paper provides further evidence in support of the proposition in the literature that the source of investment cash flow sensitivity may depend on the institutional setting of a country, such as its corporate governance.
Highlights
The influence of cash flow on firms’ investment spending has been documented as far back as the 1950s and 1960s
Max 1.96 25.46 7.9 58.89 1.26 20,400,000. This could be an indication that South African manufacturing firms are in the high Q range, which suggests that asymmetric information explanations may possibly be relevant
This paper addressed the source of investment cash flow sensitivity in South African listed manufacturing firms
Summary
The influence of cash flow on firms’ investment spending has been documented as far back as the 1950s and 1960s (see Meyer & Kuh, 1957; Donaldson, 1961). The seminal contribution in this literature is provided by Fazzari, Hubbard and Petersen (1988; 2000) These authors demonstrated that cash flow has a positive and significant effect on a firm’s investment spending and that investment cash flow sensitivity is higher in financially constrained firms than in less financially constrained firms. Kaplan and Zingales (1997; 2000) observed that less constrained firms displayed higher cash flow sensitivity to investment than more constrained firms while Clearly, Povel & Raith (2007) recorded a U-shaped investment cash flow sensitivity This nonmonotonic behaviour was observed by Guariglia (2008), Hadlock and Pierce (2010) and Hovakimian (2009)
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