Investment-cash Flow Sensitivity Research Articles

Alternative measure of financial development and investment-cash flow sensitivity: evidence from an emerging economy

This study examines the impact of financial development on corporate investment in terms of their influence on financing constraints. This study also tries to find the effect of financial development on the investment-cash flow sensitivity across the size, degree of financial constraints and group affiliation of the firm. This study employs dynamic panel data model or more specifically system generalized method of moments (GMM) estimation technique. The estimation results reveal that cash flow affects the investment decision of the company positively, which implies that Indian firms are financially constrained. Also, we observe that financial development reduces the investment-cash flow sensitivity and the effect of financial development is more prominent for small size and standalone firms. The results are robust across the period and, for both financially constrained and unconstrained firms. This study contributes to the existing literature by analyzing the impact of financial development on the role of cash flow in determining investments undertaken by the Indian firms, which is an unexplored issue from an emerging market perspective.

Does Internal Capital Market Membership Matter for Capital Allocation? Theory and Evidence from the Euro Area

The paper examines the capital allocative behavior of internal capital market (ICM) members and their comparable single-segment firms in the euro area. Results indicate that the ICM members exhibit lower investment-cash flow sensitivity, lower impact of financial flexibility, and lower levels of underinvestment and overinvestment behavior, than their peers. We find no evidence of significant value-destroying cross-subsidization within ICMs. Results document that headquarters’ monitoring and managerial discretion, cost of capital, financial flexibility, informational asymmetries and asset lumpiness appear to be significant determinants of investment behavior.

Asset-light business model: An examination of investment-cash flow sensitivities and return on invested capital

The purpose of this study is to investigate the effects of the asset-light business model on investment-cash flow sensitivities and return on invested capital in the lodging industry. Little research has explored the link between investment and asset ownership structure. The current study provides an alternative approach to examining investment behavior and return on invested capital, focusing on the unique characteristics of asset ownership among lodging firms. The findings of this study provide important implications for lodging investors and shareholders regarding the strategic use of the asset-light business model for aiding lodging firms’ efficient investments and delivering high return on invested capital.

CSR investment and cash flow sensitivity under the managerial optimism

This study analyses the cash flow sensitivity of the Corporate Social Responsibility (CSR) in the presence of managerial optimism of Chinese listed firms from 2009-2016. Using the earning forecast error, we introduce and construct a dichotomy variable as a proxy of managerial optimism to show the impact of cash flow on CSR in the presence of managerial optimism biases. The cash flow sensitivity under the managerial optimism develops the significant positive association with CSR in the whole sample. While investigating the cash flow sensitivity in constrained and less-constrained firms, we find that cash flows sensitivity is more strongly associates with CSR in constrained firms than the less-constrained firms. The study also finds that board characteristics play an essential role to reduce the cash flow sensitivity of the CSR investment.

Investment-Cash Flow Sensitivity and Financing Constraints: Study of Pakistani Business Group Firms

A large discrepancy exists on the use of the investment–cash flow sensitivity as a measure of financing constraints of firms. We examine this discrepancy by considering business group affiliated firms in Pakistan. The study includes 58 group affiliated firms and 32 non-group affiliated firms listed on the Karachi Stock Exchange during 2006-2010. Results of OLS and 2SLS shows a positive investment-cash flow sensitivity for business group affiliated firms and negative investment cash flow sensitivity for non-group affiliated firms. Additional tests accordingly express that investment-cash flow sensitivity of Pakistani group affiliated firms is significantly lower to non-group affiliated firms.

Is the investment-cash flow sensitivity divergent when information is asymmetrically distributed?

This paper deals with the asymptotic behavior of the investment-cash flow sensitivity when financing constraints are binding under asymmetrical distribution of information. A booming empirical literature showed that the investment-cash flow sensitivity can be used as a metric to measure financing constraints. Although various critiques have been addressed to this metric, it still is used in theoretical and empirical studies. I consider the bank's deterministic participation constraint, measure financing constraints parsimoniously, and infer a dynamic, linear relationship of the investment-cash flow sensitivity. The major theoretical implications of this paper show a divergence characteristic of the investment-cash flow sensitivity. Indeed, the worsening of the financial contracting terms tends to induce an infinite increase of the sensitivity. In addition, there exists a threshold level beyond which the firm is expected to be more financially constrained in the future and its investment-cash flow sensitivity is deemed to diverge more rapidly.

Stock mispricing and investment decisions: evidence from Pakistan

Purpose This study aims to examine the impact of stock mispricing on corporate investment decisions by taking the sample of non-financial firms listed on the Pakistan Stock Exchange during the period of 2008-2014. Design/methodology/approach To measure the mispricing, this study decomposes the market-to-book ratio into mispricing and growth components and measures corporate investment by capital expenditures. Fixed and random effect panel regression models are used to estimate the results. Findings Results of the study show that firms issue overvalued equity to finance the capital expenditures. Consistent with other studies, the relationship between stock mispricing and investment is more prominent in the financially constrained firms. In addition, cash flow investment sensitivity is higher in financially unconstrained firms. Practical implications Nonetheless, the results give important implications to the Pakistan Stock Market on how the mispricing enhances the welfare by relaxing the financial constraints and allowing the managers to make investment in profitable projects that otherwise go non-funded. These findings have interesting implications for further research in the literature of finance and also help in economic policy-making. Originality/value This study finds the impact of stock mispricing on corporate investment decisions by considering the role of market timing in the context of Pakistan.

Investment-Cash Flow Sensitivities Are Very Probably Not Valid Measures of Financing Constraints: on the Accounting Partial Identities Problem

This experiment uses a Monte Carlo simulation designed to test whether the problems about the use of accounting identities are present in the model of Fazzari, Hubbard, and Petersen (1988). The Monte Carlo simulation creates 10,000 sets of randomly generated cash flows, Tobin’s Q, and an error term variables, which in turn shape an investments variable that depends on them. These two variables are also related through an accounting semi identity or accounting partial identity (API). OLS estimations verify that estimated coefficients do not represent reality. The closer the data are to the accounting identity, the less the regression will tell about the causal relation.

Debt holdings and investment cash flow sensitivity of listed firms

PurposeThe purpose of this paper is to examine the effect of debt holdings on the sensitivity of firms’ investment to availability of internal funds.Design/methodology/approachFor a panel data set of 27 Ghanaian listed firms for the period 2007–2013, the paper applies the Euler equation approach to the empirical modeling of investment.FindingsThe study finds support for the assertion that listed firms face less severe corporate control problems and lower financing constraints, and thus, have lower investment cash flow sensitivities. The study also finds that a significant positive sensitivity of investment to internal funds is associated with firms that have high debt holdings.Practical implicationsAn implication of this study is that firms with high debt holdings face greater challenges in accessing external finance. These firms are likely to experience under-investment which at a macro level would translate into lower investments and economic growth for the country.Originality/valueEmpirical literature document that in the presence of market imperfections, investments of financially constrained firms become sensitive to the availability of internal finance. There are also contradictory evidences regarding the pattern of the observed investment cash flow sensitivity. This study examines the effect of debt holdings on the sensitivity of firms’ investment to availability of cash flow. This is yet to be empirically tested despite some theoretical explanations.

The Relationship Between Social Responsibility and Investment-Cash Flow ‎Sensitivity ‎ and the Role of Agency Costs

In this study, the relationship between social responsibility and investment-cash flow ?sensitivity ?and the role of agency costs in companies listed on Tehran Stock Exchange were investigated. To this end, 127 companies were examined during the period 2011-2016. The required data in this research was extracted, classified and calculated using Excel software and finally, the hypotheses were tested at a 95% confidence level through Eviews? ?and Stata software. The results obtained from hypothesis testing demonstrated that corporate social responsibility ?negatively moderates investment-cash flow ?sensitivity. Furthermore, no reliable evidence was found in relation to the effectiveness of agency costs in the relationship between social responsibility and investment-cash flow ?sensitivity at a 95% confidence level.

Investment opportunities and cash holdings of firms: an empirical study on Korean firms

ABSTRACTWe find that the cash flow sensitivity of cash holdings of firms whose investment opportunities are lower is significantly higher by examining a panel data of 898 Korean firms for 1999–2014. The cash flow sensitivity of investment is also found to be lower in case of low investment opportunity. Both findings suggest that firms decide to hold cash in response to an increase in cash flow when they do not have a good investment opportunity. Precautionary motive because of financial constraints and uncertainty, and agency problems, however, are not associated with the cash flow sensitivity of cash holdings. These findings imply that it is necessary to develop new investment opportunities to encourage firms to spend more cash in Korea.

Ownership structure, overinvestment and underinvestment: Evidence from Brazil

This paper examines whether investment-cash flow sensitivity is due to underinvestment problems caused by asymmetric information, or if it is due to overinvestment problems motivated by the use of free cash flows on unprofitable investment projects. Using a sample of 485 Brazilian firms over the period of 1997 to 2007, the results show that both underinvestment and overinvestment problems are related to the active presence of the largest ultimate shareholder on the board and the executive director. The sample was split in accordance with the presence of financial constraints (measured by the KZ index) and investment opportunities (measured by Tobin’s q). The results indicate that financially constrained firms and firms with high investment opportunities suffer from underinvestment, while financially unconstrained firms and firms with low investment opportunities suffer from overinvestment problems.

Do public-private partnerships benefit private sector? Evidence from an emerging market

PurposeWe extend the literature on Public-Private Partnerships (PPPs) to understand the benefits of these incentive-compatible contracting arrangements to the private sector firms. We argue that the unique structure of PPPs helps in mitigating information asymmetry problem that drives underinvestment in the private sector of emerging markets and thereby enhances their investment efficiency. We test this hypothesis on PPPs that occurred in India over the last one decade. MethodologyWe consider the investment-cash flow sensitivity. FindingsWe find that, compared to the matched non-PPP investments made by the private sector firms, PPP investments result in significant reduction of investment cash flow sensitivity in the post-PPP investment period. Also, in the long run, the operating performance of the private sector firms improves in the post-PPP investment period. However, these benefits are sensitive to the nature of firm, commitment level of private sector and Government concessions. Overall, our results concur with the rising popularity of PPPs. OriginalityOur paper is the first study that examines the benefits of PPP for private firms.

Corporate governance, accounting information environment and investment-cash flow sensitivity

PurposeThe purpose of this paper is to test the effects of antitakeover protection on investment-cash flow sensitivity and whether these effects are moderated by firms’ accounting information environment and agency problems.Design/methodology/approachTo test the effects of agency problems, the authors use the passage of second-generation antitakeover laws as the testing ground, which is a pseudo-natural experiment that is widely used in the accounting, finance and economics literature (e.g. Armstrong et al., 2012; Bertrand and Mullainathan, 2003).FindingsThe authors’ analysis shows that investment-cash flow sensitivity is greater when managers are insulated from takeovers. The authors’ results also demonstrate that the effects of the passage of antitakeover laws on investment-cash flow sensitivity are greater when firms’ accounting information environment is poor, which is measured by fewer analysts following and higher analyst forecast dispersion. The authors also show that the effects of the passage of antitakeover laws on investment-cash flow sensitivity are greater when firms have severe agency problems, which are measured by more free cash flow.Originality/valueThe authors’ research extends the empirical accounting literature about the effects of corporate governance and accounting information environment on firms’ operating and financial decisions.

Earnings quality, investment decisions, and financial constraint

Purpose – The purpose of this study was to investigate the relationship between accruals quality, financial constraint, and investment decisions and if earnings quality affects investment-cash flow sensitivities. Design/methodology/approach – An analysis was conducted of a sample with 10,318 observations of 958 non-financial companies from seven different countries, covering 1992 to 2009. Then, the investment determinants were estimated using the Generalized Method of Moments (GMM). Findings – Poor accruals quality was positively associated with investment rates for firms with overinvestment and negatively related to investment rates for firms with underinvestment. Additionally, the results indicate that accruals quality affects investment-cash flow sensitivities for firms in a situation of financial constraint; that is, poor accounting information quality can exacerbate the dependence of investment on free cash flow. Originality/value – The results show that poor accruals quality could exacerbate the problems caused by the conflict of interest between decision-makers and shareholders or other stakeholders.

Evidence on the determinants of investment-cash flow sensitivity

Investment-cash flow sensitivity (ICFS) is commonly used to investigate finance constraints in firms. However, there are several criticisms of ICFS that need to be confronted. First, higher ICFS may signal preference for internal funds, even when external funds are available on competitive terms. Second, ICFS may not increase monotonically with the finance constraints. Finally, cash flows, apart from capturing information on internal liquidity, also capture information on growth opportunities of firms. Evaluating the ICFS at firm level, the results suggest that ICFS is largely non-monotonic and it cannot be unambiguously associated with finance constraints based on firm characteristics.

Investment-cash flow sensitivity and the Bankruptcy Reform Act of 1978

We exploit a change in bankruptcy law in 1978 in the U.S. as an exogenous shock that increased the cost of external funds for public companies. In a quasi-natural experiment setting, we investigate the impact of an increased cost of debt on the investment-cash flow sensitivity of firms. Our results show that the sensitivity of investment to cash flow increased by one third after 1978, and for a sample of firms likely to be more financially constrained the effect was as high as 80%. Our findings suggest the market value of a dollar in cash holdings increased by 12 cents after the change in law, with a larger effect for financially constrained firms.

The impact of tax avoidance on enterprise investment efficiency

Focusing on the economic consequences of tax avoidance, this paper tries to explore the impact of a company’s tax avoidance, especially the correlation between tax avoidance and overinvestment, based on the conditions of the companies listed on the Shanghai & Shenzhen Stock Exchanges (A–share companies). Our study reveals that a higher level of tax avoidance is associated with higher investment–cash flow sensitivity as well as a tendency to overinvest. This finding may be useful to enterprises when they choose their tax avoidance activities.

Effect of political connections on corporate financial constraints: new evidence from privatization in China

ABSTRACTTaking advantage of the SOEs privatization events in China, our research looks to identify the causal effect of political connections on corporate financial constraints. In a difference-in-differences framework, we demonstrate that after the transfer of control from state to private owners, privatized SOEs hoard more cash, save more cash from incremental cash flow, and exhibit higher cash flow sensitivity of investment.

Financial Structure and Financing Constraints: Evidence on Small- and Medium-Sized Enterprises in China

The difficulty of financing for small- and medium-sized enterprises is an important problem that has plagued China’s economic development for a long time, so it is of great practical significance to explore how to solve the problem of financing difficulties for small- and medium-sized enterprises. From the perspective of financial structure, this paper introduces it to the analytical framework of the investment-cash flow sensitivity model, and establishes a two-way fixed effect model on the basis of the financial structure and other external financing conditions, so as to study the impact of the financial structure in China, especially the banking structure, on the financing constraints of small- and medium-sized enterprises. At the same time, the data of 161 listed companies on the Small and Medium Enterprise Board from 2009 to 2013 is used to carry out an empirical test on the correlation between the financial structure factors and the financing constraints of small- and medium-sized enterprises. The study shows that the promotion of the scale ratio of small- and medium-sized enterprises in the banking industry is able to significantly alleviate the financing constraints of small- and medium-sized enterprises. Meanwhile, the structure of the banking industry should adapt to the industrial structure, in order to achieve the sustained and stable development of the real economy.