Cash Flow Sensitivity Research Articles

The impact of shareholder intervention on overinvestment of free cash flow by overconfident CEOs

This paper examines the impact of shareholder intervention on investment distortions, which we capture using overinvestment of free cash flow by overconfident CEOs. Using this definition and U.S. data for 1996–2014, our fixed effects and difference-in-difference matching estimation results provide consistent evidence that the threat of potential intervention of shareholders can curb overinvestment by overconfident CEOs. Specifically, firms with greater voting premium and hedge fund activism experience less overinvestment and exhibit lower sensitivity of free cash flow to investment. Such disciplining effects are stronger for firms managed by overconfident CEOs. Overall, our results suggest that shareholder intervention is particularly effective at mitigating overinvestment that is more likely to be distorted.

The application of proxy methods for estimating the cost of equity for unlisted companies: evidence from listed firms

The Campbell and Vuolteenaho (Am Econ Rev 94(5):1249–1275, 2004) two–beta model decomposes the systematic risk in the sensitivity of cash flow and discount rate change. We employed this model, which we call the Two Beta Decomposition Model (TBDM) and found that this model is useful to compute the cost of capital for unlisted companies (UCs) via a proxy from listed companies. This model includes not only the accounting return reaction to long-term changes in consumption, but also links fundamental reactions to temporal changes in risk aversion. We test this model along with three traditional alternatives that are potentially useful in computing the cost of equity for UCs: accounting betas (AB), unlevered betas (UB), and operational betas (OB). Our results show that AB, UB and TBDM can partially explain the cross-sectional variations of stock returns. Additionally, using a series of non-parametric ranking test along with several statistics of goodness of fit, we found that the TBDM is the model that produces the best fit among competing models followed by the UB which is currently the most used among proxy methods.

The Indirect Impact of Busy Directors on the Relationship of Family Structure and Cash Flow Sensitivity of Cash (Empirical Research in Indonesia’s Manufacturing Sector 2013-2017)

Research aims: This research aimed to determine the impact of family structure on the cash flow sensitivity of cash (CFSC) in the manufacturing sector. It also investigates the indirect impact of busy directors as a moderating effect.Design/Methodology/Approach: Based on a sample of Indonesia’s manufacturing companies from 2013 to 2017, the researcher uses GLS regression models on this panel data calculated with robustness fit test at the firm’s level.Research findings: It indicated that family structure has a impact positively on cash flow sensitivity of cash and statistically significant. Meanwhile, the indirect impact of busy directors found to have a impact negatively and weakened on the relationship of family structure and CFSC, it also indiciated that quality of busy directors is an tool of corporate governance that is effectively to monitor of every family firm’s decisions.Theoretical contribution: This article enriches previous literature by justifying the impact of busy directors on the relation between every each of family’s firm decision and CFSC. Furthermore, it showed us a metric for agency problems that is the sensitivity of cash to corporate cash flows.Implication policy: Based on POJK regulations, the context of busy directors in this research refers to the roles and duties of the Board of Commissioners (BOC) which concurrently hold positions for other public companies.Research Limitation/Implication: The implications suggest that almost most of Indonesian family corporation are tend to expropriate minority by extracting rents through coporate cash flow sensitivity of cash behavior.

Managerial optimism, investment cash flow sensitivity and agency costs: Evidence from NYSE panel data firms

This study deals with a new survey for the relationship between CEO optimism and investment cash flow (ICF) sensitivity in presence of asymmetric information and agency costs problems. In this paper, we conduct an empirical study of ICF among NYSE manufacture firms during the period 1999–2010. Our results report that the ICF sensitivity exists and is significant especially for firms that run agency costs. This result is robust to a battery of different model including alternative assumptions and different methodologies based on Adjusted Q-model and Euler equation model. For another set of tests, we demonstrate that a large blockholders holding may succeed to reduce investment cash flow caused by CEOs optimism bias.

“One person’s decision” or “collective voting”: Evidence of overconfident investing in Chinese listed companies

This study explores the collective voting of Chinese listed companies by examining whether the overconfidence of the board chairperson could affect the relationship between overconfidence and investment–cash flow sensitivity by the board of directors. On average, the board of directors’ overconfidence leads to increased investment–cash flow sensitivity. However, this influence is driven by state-controlled listed companies only if the chairperson is overconfident. The results suggest that the chairperson’s overconfidence may impact the relationship between the board of directors’ overconfidence and investment–cash flow sensitivity. Furthermore, the investment distortion due to the board’s overconfidence behavior may be alleviated by supervising the chairperson.

Financial constraints and cross-listing

We examine whether alleviating financial constraints is one of the motives for non-U.S. firms to cross-list in stock markets in the United States. Using payout ratio, payout level, and WW index (Whited and Wu, 2006) as measures of financial constraints, we find that firms with higher financial constraints are more likely to cross-list in the U.S. This pattern is driven by small firms, which tend to be financially constrained. After firms cross-list, they significantly increase their payout ratio and payout level. Small firms have more increases in payouts than large firms. WW index decreases for small firms after cross-listing. Tests about cash flow sensitivities of cash also suggest that the decline in financial constraints is more significant for small firms. Overall the results suggest that relief from financial constraints may be an important motive for cross-listing, especially for small firms.

Foreign Investors and Target Firms’ Financial Structure: Cavalry or Locusts?

We study how FDI affects the financial structure of targeted firms, by looking at a sample of foreign acquisitions that occurred in Italy between 1998 and 2016. We show that the entry of foreign investors promotes the diversification of financing sources. Moreover, foreign acquisitions lower investment sensitivity to the availability of bank credit and the cash flow sensitivity of cash, allowing targeted firms to rely more on non-bank external financing channels. Importantly, these effects are stronger for investment in intangible assets. These findings suggest that the positive productivity effects of FDI emphasized in the literature are, at least in part, traceable to enhanced investment in capital that is harder to finance through the banking sector.

The Cash Flow Sensitivity of Cash: Replication, Extension, and Robustness

This paper reexamines the empirical evidence on the cash flow sensitivity of cash presented by Almeida, Campello, and Weisbach (2004). The original paper introduces a model in which financially constrained firms choose to save cash out of incremental cash flows but financially unconstrained do not. The authors find evidence consistent with this hypothesis on a sample of U.S. public firms between 1971 and 2000. This paper extends that analysis in a number of ways. In particular, it uses a larger sample covering the 1971–2019 window, considers a number of alternative definitions of financial constraints, and incorporates new methods and tests suggested by Welch (2020), Almeida, Campello, and Galvao (2010), and Grieser and Hadlock (2019). The original empirical findings are robust to these alternative specifications.

CEO's education and investment–cash flow sensitivity: an empirical investigation

PurposeThe purpose of this study is to examine the impact of financial and technical education of chief executive officer (CEO) on investment–cash flow sensitivity (ICFS) of Indian manufacturing firms.Design/methodology/approachThe study uses the dynamic panel data model and more specifically, the system-generalized method of moments (GMM) technique to investigate the effect of CEOs' education on ICFS of Indian manufacturing firms during the period 1998–1999 to 2016–2017.FindingsThe study shows that financial (technical) education of CEOs does (not) affect ICFS. The results explain that the role of the CEO's education in ICFS is highly significant during the crisis period. The robustness test depicts that the influence of financial education on ICFS is less (more) for group-affiliated and large-sized firms (stand-alone and small-sized firms). Further, the CEO's education is significantly associated with corporate investment decisions.Research limitations/implicationsDue to the unavailability of the CEO's compensation data for the selected sample, future research could explore the impact of CEO's education with respect to CEO's compensation on ICFS.Practical implicationsFirst, the authors find that financially educated CEOs affect ICFS; therefore, firms should take care of CEO's education during recruitment of CEOs. Second, lending agencies should also consider the educational background of the CEO before approval of funding to make it safe. Third, investors should keep in mind the educational background of the CEO for the growth of their investment as it may be easier for financially educated CEOs to borrow from the market at the time of requirement.Originality/valueThis study contributes to the existing literature by providing empirical evidence through analyzing the impact of a CEO's education on ICFS in the context of India. This study is very unique in itself as it uses the sample of manufacturing sectors of India, which are growing very fast and attracting global investors to create a global hub of manufacturing in India. This study also considers different types of education such as financial and technical education of CEOs in the context of a developing economy like India. This study made its findings robust across company characteristics and periods based on the financial crisis.

Investment–cash flow sensitivity around the crisis: are African firms different?

PurposeThis paper examines the contentious relationship between investment and cash flow using the 2008–2009 credit supply shock as a form of the quasi-natural experiment.Design/methodology/approachPanel threshold models with unknown sample separation are estimated for a sample of publicly listed firms from nine African countries over the period 2003–2012. Using this approach reduces subjective or ex ante sample-splitting bias that is not accounted for in the extant literature.FindingsThe findings of the study indicate that investment–cash flow sensitivity is decreasing even during the global financial crisis (GFC) and for firms more likely to be financially constrained. The authors conclude that the usefulness of investment–cash flow sensitivity as a proxy for financial constraints is diminishing over time, even after directly addressing biases from ex ante subjective sample splitting and various forms of endogeneity.Originality/valueThe authors provide new empirical evidence from sharper tests of financial constraints for understudied African firms and highlight the need to relook at the usefulness of investment–cash flow sensitivity as a proxy of financial constraints.

Do financial restricted companies use the cash flow for investment or for cash holdings?

The present paper aims to verify whether the most financially restricted companies use their cash flow for investment or for cash holdings. To this end, the cash flow sensitivity of investment as well as the cash flow sensitivity of cash for Brazilian publicly traded companies through the Threshold method is tested, given its classification in restricted and unrestricted companies. In this context, the models of Fazzari, Hubbard and Petersen (1984) and Almeida, Campello and Weisbach (2004) were applied, using as structural breaks the Dividends Paid, Total Assets, Z-score and KZ-index. The result of the analysis was not clear in relation to which behavior is predominant in Brazilian companies. Using the Total Asset as a Threshold, the model that was most representative was the one referring to investments in capital goods. But, considering the Z-score as a Threshold, the most representative model indicates that companies use more Cash Flow results for cash holdings. Dividends and KZ-index were not significant in the analysis.

Marking to Market Corporate Debt

Models of capital structure and credit risk make predictions about market valuations of debt, but are routinely tested on the basis of book debt from common data sources. In this paper, we propose to close this gap. We construct a rich data set on firm level debt market valuations by carefully matching data on corporate bond and loan secondary market transactions. We document significant discrepancies between market and book values, especially for distressed firms. We use our dataset to i) provide novel rules of thumb on how to adjust leverage and unlever returns using standard datasets, and ii) to revisit a number of prominent empirical patterns involving corporate debt. Using a market-based measure of Tobin's Q, we find little evidence for investment cash-flow sensitivity in our data. We find that using market debt values significantly improves default prediction, and do not detect a credit spread puzzle. In asset pricing tests, we find a leverage premium, but no evidence for a value premium after controlling for market leverage. Moreover, a novel measure of financial distress, namely market-to-book debt, predicts stock returns positively in the cross-section, inconsistent with a financial distress puzzle.

BNDES loans and the financial constraints of Brazilian publicly traded companies

Purpose The purpose of this paper is to analyze whether companies that contracted loans from the Brazilian National Bank for Economic and Social Development (BNDES) between 2002 and 2014 were able to invest more than companies that did not. The literature on financial constraints, particularly that based on the investment-cash flow sensitivity model, is among the most studied and controversial in the area of finance, and the discussion on the role of development banks is equally controversial. Design/methodology/approach The main econometric model of this study was based on the investment-cash flow sensitivity model, with the incorporation of a binary variable that captures the role of the BNDES. This model is applied to a sample of companies listed on the B3 from 2002 to 2014. Findings This study shows that loans from the BNDES amplify the effects of cash flow on investments, generating a kind of credit multiplier. An important role of development banks is to reduce the financial constraints typical of developing countries. Research limitations/implications The use of the cash flow sensitivity model in companies that contracted loans from the BNDES is a relevant instrument to test the effect of the BNDES on companies with financial constraints. Practical implications The contracting of BNDES loans by companies can affect both capital structure and cash generation, particularly in companies or years in which there was financial constraint. Social implications Due to the nature of the BNDES as a development bank, there are ramifications in terms of the generation of employment and income inherent to the mission of this type of institution. Knowing the multiplier effect on the cash flow potential of companies has a direct impact on their preservation, enabling them to maintain and expand the supply of jobs. Originality/value This study is the first to integrate two important areas of study. From the theoretical perspective, this study provides evidence on the relationship between the BNDES and company financial constraints that open new avenues of research. From the managerial point of view, the evidence of the multiplier effect is highly important for the management of the capital structure and cash flow of companies.

THE EFFECT OF FINANCIAL CONSTRAINT MODERATION IN CASH FLOW SENSITIVITY TO EXTERNAL FINANCING OF MANUFACTURING COMPANIES

This study aims to test the pecking order theory by looking at the level of cash flow sensitivity as a source of internal financing for all types of external financing (debt and equity). This testing also considering the financial constraint variable as moderation. The data used are the financial statements of manufacturing companies listed on the Indonesia Stock Exchange in 2014 - 2018. The dependent variable is all types of external financing (debt and equity). Debt financing is divided into two forms, short-term debt financing and long-term debt financing. While the independent variable is cash flow. The results obtained is that cash flow does not substitute all types of external financing, and the highest cash flow sensitivity occurs in short-term debt financing. The next result is that financial constraint strengthen the sensitivity of cash flow to debt and equity financing

Macroeconomic conditions and investment–cash flow sensitivity: Evidence from Saudi Arabia

AbstractThe purpose of this paper is to examine whether the investment–cash flow (ICF) sensitivities vary with macroeconomic conditions. A fixed‐effect panel technique with OLS regression is used to investigate the impact of macroeconomic factors on the ICF sensitivity applying data from a sample of 74 non‐financial firms listed on the Saudi stock market over the period 2004–2018. The results show that the ICF sensitivity is positive, and is a lot larger for more constrained firms. Compared to developed markets, the results show higher ICF sensitivity in Kingdom of Saudi Arabia (KSA). Moreover, the results reveal that business environment of KSA has a considerable influence on the sensitivity of investment to internal funds. The evidence also shows that better macroeconomic conditions relax financial constraints faced by firms, and thereby reduce the sensitivity of investment to internal financing. Expansionary monetary policy, financial development and liquidity abundance reduce the dependence of firms on their internally generated funds when undertaking new investment projects. Finally, the results show that investment expenditures are more sensitive to internal cash flow during the crisis period, supporting our conjecture that constrained access to capital markets is more likely to be detected during times of liquidity crises.

Why Did the Investment–Cash Flow Sensitivity Decline over Time?

AbstractWe propose an explanation for why corporate investment used to be sensitive to cash flow and why the sensitivity declined over time. The sensitivity stems from the informational role of cash flow in inferring the productivity of tangible capital in the old economy. Over time, however, more new-economy firms enter the market. These firms have reduced tangible capital productivity and reduced cash-flow predictability, which drives the decline in the average investment–cash flow sensitivity. Theoretical and empirical analyses support this explanation.

Inventory investment and cash flow sensitivity: evidence from Turkish firms

Purpose - This study analyzes the inventory investment – cash flow sensitivity for 166 manufacturing firms in Turkey listed in Borsa Istanbul. The time spans 2006-2018. Methodology - Based on the previous literature, Lovell’s (1961) target adjustment model is used. The baseline equation model is estimated by the system Generalized Method of Moments (GMM). Findings- The relationship between inventory investment and cash flow is statistically positive for constrained firms, while insignificant for unconstrained firms according to all models. The effect of Gross Domestic Product (GDP) on inventory investment is positive and significant for both constrained and unconstrained firms, this implies that GDP contributes to an increase in inventory investment. Conclusion- This study is the first one that analyzes the inventory investment and cash flow relationships for Turkish manufacturing firms and wants to fulfill this gap in the literature. It is found that cash flow is positively significant for constrained firms according to size and age classification criteria.

Innovation and Investment in High-Tech Firms in Financially Constrained Environment

Present study measures the effect of financing constraints on capital investment and innovation investment of Chinese firms from 2004-2015. Consistent with previous literature we use the sensitivity of investment to cash flow and sensitivity of innovation investment as a signal of financial constraints. Panel data estimation results lead us to arrive at three important conclusions. First; Chinese firms usually face financial constraints problems due to imperfect financial markets. Second; Chinese firms face investment cash flow sensitivity. Third; Chinese high-tech firms face innovation investment cash flow sensitivity. Hence, despite the financial efforts of the Chinese government, capital markets are still not efficient and create liquidity constraints. Results depict that firms classified a priori as more prone to financial constraints (based on KZ index) show higher sensitivity to cash flow.

Corporate strategy uniqueness, analyst herding, and financing constraints

This study is based on the premise that firms pursuing unique corporate strategies impose a high information cost on security analysts. A difficult information environment will foster analyst herding and lead to financing constraints for firms with unique corporate strategies. We find that corporate strategy uniqueness is positively related to analyst herding, which suggests that strategy uniqueness is associated with greater information asymmetry between corporate insiders and outsiders. Furthermore, we find that firms with more unique strategies have higher investment–cash flow sensitivity, indicating that strategy uniqueness makes it harder for firms to obtain external financing. Our findings contribute to research about the consequences of pursuing strategies that security analysts are unwilling or unable to value.

Targeted monetary policy and financing constraints of Chinese small businesses

This study examines the effect of targeted easing (TE), an unconventional monetary policy designed to reduce reserve requirement ratios (RRR) of selected financial institutions, on reducing financing constraints of Chinese small businesses. Using a longitudinal sample of listed small businesses between 2003 and 2018, we find that the implementation of a TE policy significantly reduces financing constraints of small businesses as measured by the cash flow sensitivity. In addition, the policy effect is stronger when reductions in RRR are targeted at financial institutions specialized in small business lending than at banks with a threshold level of small business loans. We also document that small businesses with larger financing needs benefit significantly more from the TE policy and experience a larger reduction in their financial constraints. Moreover, the TE policy effect is more salient in state-owned small businesses than privately controlled enterprises. These results are also robust to alternative measures of financing constraints.