Cash Flow Sensitivity of Investment

Investment cash flow sensitivity is associated with both underinvestment when cash flows are low and overinvestment when cash flows are high. The accessibility of external capital is positively correlated with cash flows, intensifying investment cash flow sensitivity. Managers actively counteract the variations in internal and external liquidity by accumulating working capital when liquidity is high and draining it when liquidity is low. These results imply that cash flow sensitive firms face financial constraints, which are binding in low cash flow years. Traditional indicators of financial constraints, such as size and dividend payout, successfully distinguish firms that may potentially face constraints, but are less successful in distinguishing between periods of tight and relaxed constraints. These periods are much more clearly separated by the KZ index, which, on the other hand, is less successful in identifying firms that are likely to face liquidity constraints.     

Effects of financial constraints on corporate policies in Australia

We jointly study the impact of financial constraints on Australian companies’ investment decisions and demand for liquidity. By examining a large sample of Australian firms over the period 1990–2003, we find that financial constraints not only reduce the sensitivity of investment to the availability of internal funds, but also increase the responsiveness of cash holdings to internally generated cash flows. Further analysis shows that the impact of financial constraints varies across different cash flow states; that is, financial constraints have a small effect on corporate investment and cash policies when cash flows are positive. In contrast, the severity of constraints is high in negative cash flow years in which the cost disadvantage of external finance coincides with deteriorating operating performance.     

The impact of cash flows and firm size on investment: The international evidence

This paper examines the degree to which cash flow availability influences firm investment in six OECD countries. In particular, we are interested in the extent to which the reliance on internal funds is affected by firm size, since there is general agreement that smaller firms have less access to external capital markets and, thus, should be more affected by the availability of internal funds. Earlier work has concluded that the documented positive relationship between cash flow and investment is evidence of the existence of financial constraints. We first examine all firms, regardless of size, in each country, and we find that the amount of corporate investment is affected by internal resources in all six countries; that is, internal financing affects firm investment. We then repeat the analysis segmenting the sample using three measures of firm size. Contrary to our a priori expectations, we find that the cash flow-investment sensitivity is generally highest in the large firm size group and smallest in the small firm size group. We deduce that the explanations for these findings are grounded in managerial agency considerations, and in the greater flexibility enjoyed by large firms in timing their investments. Thus, we conclude that the degree of sensitivity of a firm's investments to its cash flows cannot be interpreted as an accurate measure of its access to capital markets (as do Kaplan, S., Zingales, L., 1997. The Quarterly Journal of Economics 169–215), since small firms are known to have less access to external markets.     

The Effects of Liquidity Shocks on Corporate Investments and Cash Holdings: Evidence from Actuarial Pension Gains/Losses

This paper investigates how anticipated liquidity shocks affect corporate investment and cash holdings by examining the impacts of actuarial pension gains/losses that do not reduce current internal resources but will reduce those available in the future. Using a sample from Japanese manufacturing firms in which pension deficits had a huge impact on the internal resources of sponsoring firms, I show that pension losses significantly decrease the capital expenditures of sponsoring firms. Pension losses also increase corporate cash holdings, suggesting precautionary demands for cash prepared for future pension contributions. Overall, the results indicate that managers consider anticipated liquidity shocks in determining current investment and cash‐saving policies.     

The impact of labor unions on investment-cash flow sensitivity

This paper empirically examines how labor unions affect investment-cash flow sensitivity using samples from the US covering the period of 1984–2009. We find a significant positive union effect using a q model of investment. The capital expenditures of firms are 1.71 times more sensitive to internal cash flows when unionization rates increase one standard deviation from the mean. This effect holds when we control for other proxies of financial constraints. In addition, unionized firms are associated with lower cash–cash flow sensitivity, which suggests that the higher investment-cash flow sensitivity in unionized firms is primarily driven by the incentive of these firms to reduce liquidity and enhance bargaining power against the union. We also show that the above union effects become more pronounced during labor contract negotiation years.     

自由现金流量创造力与违约风险——来自A股公司的经验证据

本文基于我国A股上市公司数据,研究了企业自由现金流量创造力与违约风险之间的关系。研究发现:(1)企业自由现金流量创造力越强,其违约风险越低。经过一系列稳健性检验后,该结论依旧成立。(2)自由现金流量创造力越强的企业往往有更低的债务规模、更高的资产收益率和更低的股票波动,因而其违约风险更低。(3)自由现金流量创造力与违约风险的负相关关系,主要存在于货币政策紧缩时期以及外部信息环境较差的企业。本文发现意味着,监管部门和投资者应重视上市公司自由现金流量创造力不足所带来的潜在债务违约风险,通过不断提高公司自由现金流量创造力,助力我国宏观经济与微观企业高质量发展。     

Optimal investment with fixed financing costs

Models with a premium on external finance produce counterfactual predictions about liquidity management. We address this shortcoming by introducing a fixed cost of increasing external finance into an otherwise standard investment/financing problem. This additional financial friction is well-motivated by case studies and our analysis shows that it generates more realistic predictions about liquidity management: firms hold external finance and idle cash simultaneously, and may invest an additional dollar of cash flow in liquidity rather than repaying external funds or investing in productive capital. In addition to better fitting the stylized facts about the time-series and cross-sectional pattern of liquidity holding, these results may help shed light on the fragility of estimates of investment–cash flow sensitivities.     

Cash Holdings and Corporate Diversification

This paper studies the relation between corporate liquidity and diversification. The key finding is that multidivision firms hold significantly less cash than stand‐alone firms because they are diversified in their investment opportunities. Lower cross‐divisional correlations in investment opportunity and higher correlations between investment opportunity and cash flow correspond to lower cash holdings, even after controlling for cash flow volatility. The effects are strongest in financially constrained firms and in well‐governed firms, and correspond to efficient fund transfers from low‐ to high‐productivity divisions. Taken together, these results bring forth an efficient link between diversification and corporate liquidity.     

The Impact of Investment Opportunities and Free Cash Flow on Financial Liberalization:A Cross-Firm Analysis of Emerging Economies

This study undertakes firm-level analysis of investment opportunities and free cash flow in an attempt to explain the source of the wealth effect of financial liberalization for 14 emerging countries. We find that the market's responses to stock market liberalization announcements are more favorable for high-growth firms than for low-growth firms, a result that is consistent with the investment opportunities hypothesis. We also demonstrate that firms with high cash flow experience lower announcement-period returns associated with stock market liberalization than do firms with low cash flow. Our findings suggest that the free cash flow hypothesis dominates the corporate governance hypothesis in terms of the net effect of stock market liberalization on a firm's stock returns. We further document similar evidence with regard to banking liberalization. Finally, we demonstrate that stock market liberalization leads to the more efficient allocation of capital.     

Is Investment‐Cash Flow Sensitivity Caused by Agency Costs or Asymmetric Information? Evidence from the UK

We investigate the investment‐cash flow sensitivity of a large sample of the UK listed firms and confirm that investment is strongly cash flow‐sensitive. Is this sensitivity a result of agency problems when managers with high discretion overinvest, or of asymmetric information when managers owning equity are underinvesting if the market (erroneously) demands too high a risk premium? We find that investment‐cash flow sensitivity results mainly from the agency costs of free cash flow. The magnitude of the relationship depends on insider ownership in a non‐monotonic way. Furthermore, we obtain that outside blockholders, such as financial institutions, the government, and industrial firms (only at high control levels), reduce the cash flow sensitivity of investment via effective monitoring. Finally, financial institutions appear to play a role in mitigating informational asymmetries between firms and capital markets. We corroborate our findings by performing additional tests based on the stochastic efficient frontier approach and power indices.     

Internal financial constraints,external financial constraints,and investment choice: Evidence from a panel of UK firms

This paper uses a panel of 24,184 UK firms over the period 1993–2003 to study the extent to which the sensitivity of investment to cash flow differs at firms facing different degrees of internal and external financial constraints. Our results suggest that when the sample is split on the basis of the level of internal funds available to the firms, the relationship between investment and cash flow is U-shaped. On the other hand, the sensitivity of investment to cash flow tends to increase monotonically with the degree of external financial constraints faced by firms. Combining the internal with the external financial constraints, we find that the dependence of investment on cash flow is strongest for those externally financially constrained firms that have a relatively high level of internal funds.     

The Interdependent and Intertemporal Nature of Financial Decisions: An Application to Cash Flow Sensitivities

We develop a dynamic multiequation model where firms make financing and investment decisions jointly subject to the constraint that sources must equal uses of cash. We argue that static models of financial decisions produce inconsistent coefficient estimates, and that models that do not acknowledge the interdependence among decision variables produce inefficient estimates and provide an incomplete and potentially misleading view of financial behavior. We use our model to examine whether firms are constrained from accessing capital markets. Unlike static single‐equation studies that find firms underinvest given cash flow shortfalls, we conclude that firms maintain investment by borrowing.     

Corporate precautionary cash holdings

This paper models the precautionary motive for a firm's cash holdings. A two-period investment model shows that the cash holdings of financially constrained firms are sensitive to cash flow volatility because financial constraints create an intertemporal trade-off between current and future investments. When future cash flow risk cannot be fully diversifiable, this intertemporal trade-off gives constrained firms the incentives of precautionary savings: they increase their cash holdings in response to increases in cash flow volatility. However, there is no systematic relationship between cash holdings and cash flow volatility for unconstrained firms. We test the empirical implications of our theory using quarterly information from a sample of U.S. publicly traded companies from 1997 to 2002, and find that the empirical evidence supports our theory.     

Accounting for investments and the relevance of losses to firm value

Recent research has documented investment in research and development as a key driver of the market value of currently unprofitable firms (hereafter loss firms) in a knowledge-based economy. We broaden this argument to consider the influence of accounting for investments in general on the relation between current profitability and firm value for loss firms. Specifically, in the context of a resource-based economy, we find that exploration costs, cash flow measures of investment, and research and development costs help to explain the value of loss firms and reduce the negative relation between current profitability and firm value.     

How Does Being Public Affect Firm Investment? Further Evidence from China

What role does the stock market play in the allocation of capital? Few studies have examined how being public affects firm investment in emerging markets. This study fills this gap by comparing investment behavior in public and private Chinese firms over the period 2004–2010. We find an overall improved capital allocation of public firms relative to private firms in China. By disentangling the financial constraints effect from the agency effect, we show that public firms are less likely to underinvest when there is cash flow insufficiency and more likely to overinvest when there is free cash flow. We conclude that both effects coexist and that whether or not being public improves investment behavior depends on the net effect of loosening financial constraints and worsening agency conflicts. Further examination shows that financial information plays a limited role in these effects, implying that the association between being public and firm investment may not be attributed to information asymmetry but, rather, institutional arrangement in China.     

Productivity and liquidity management under costly financing

We explore theoretically and empirically the relationship between firm productivity and liquidity management in the presence of financial frictions. We build a dynamic investment model and show that, counter to basic economic intuition, more productive firms could demand less capital assets and hold more liquid assets compared to less productive firms when financing costs are sufficiently high. We empirically test this prediction using a comprehensive dataset of Chinese manufacturers and find that more productive firms indeed hold less capital and more cash. We do not, however, observe this for US manufacturers. Our study suggests a larger capital misallocation problem in markets with significant financing frictions than previously documented.     

The Determinants of Leveraged Buyout Activity: Free Cash Flow vs. Financial Distress Costs

This paper investigates the determinants of leveraged buyout (LBO) activity by comparing firms that have implemented LBOs to those that have not. Consistent with the free cash flow theory, we find that firms that initiate LBOs can be characterized as having a combination of unfavorable investment opportunities (low Tobin's q) and relatively high cash flow. LBO firms also tend to be more diversified than firms which do not undertake LBOs. In addition, firms with high expected costs of financial distress (e.g., those with high research and development expenditures) are less likely to do LBOs.     

Corporate liquidity,investment and financial constraints: Implications from a multi-period model

In single period models, financially constrained firms invest more in response to increases in their net worth or interest rate cuts. We examine whether or not these results necessarily hold in a multi-period setting. We present a multi-period version of the Holmstrom and Tirole moral hazard model and show that the probability of investment (or the hurdle rate for investment) in the first period of a two-period model is non-monotonic in the level of liquid balances [Holmstrom, B., Tirole, J., 1997. Financial intermediation, loanable funds, and the real sector. Quart. J. Econ. 112 (3), 663–691. August; Holmstrom, B., Tirole, J., 1998. Private and public supply of liquidity. J. Polit. Economy 106 (1), 1–40. February; Holmstrom, B., Tirole, J., 2000. Liquidity and risk management. J. Money, Credit, Banking 32 (3), 295–319. August]. When a risk-free interest rate is introduced in the model, we show that a lower interest rate (or a downward shift or the yield curve) can lead to less current investment due to the interaction of future financial constraints and discounting of cash flows. Our results have implications for the effect of monetary policy on investment by financially constrained firms. They also address several recent empirical debates, such as the relationship between liquidity and the cash-flow sensitivity of investment, and whether or not accumulation of cash balances by Japanese firms can be consistent with the existence of financial constraints affecting investment.     

Zero-leverage policy and stock price crash risk: Evidence from Korea

This study examines the difference in stock price crash risk between zero-leverage and non-zero-leverage firms. We find that zero-leverage firms have a significantly higher future stock price crash risk than non-zero-leverage firms. Next, we find that the positive relation between zero-leverage policy and future stock price crash risk is more pronounced when firms have higher controlling shareholders' ownership and foreign ownership. We also find that the positive relation is more pronounced for firms with low cash holdings than for those with high cash holdings. Further, we find that the positive relation is stronger for dividend-paying firms than non-dividend-paying firms. Our results are robust to alternative estimation specifications and endogeneity concerns. Overall, our findings shed light on the extent to which extreme corporate financial policy has an impact on future stock price crash risk. Our empirical evidence also provides meaningful implications for how stakeholders (especially investors) predict stock price crash risk in the context of extremely conservative capital structure.     

The Cash Flow Sensitivity of Cash

We model a firm's demand for liquidity to develop a new test of the effect of financial constraints on corporate policies. The effect of financial constraints is captured by the firm's propensity to save cash out of cash flows (the cash flow sensitivity of cash). We hypothesize that constrained firms should have a positive cash flow sensitivity of cash, while unconstrained firms' cash savings should not be systematically related to cash flows. We empirically estimate the cash flow sensitivity of cash using a large sample of manufacturing firms over the 1971 to 2000 period and find robust support for our theory.