Institutional investment horizon and investment–cash flow sensitivity

This paper examines the relevance of institutional investors’ investment horizon, as reflected in the response of firm investment to internal cash flows. We argue that institutional investors with longer investment horizons have greater incentives and efficiencies to engage in effective monitoring. This improved monitoring mitigates asymmetric information and agency problems, and in turn reduces the wedge between the costs of internal and external funds. As a result, the sensitivity of firms’ investment outlays to internal cash flows decreases in the presence of institutional investors with long-term investment horizons. Using a sample of 8402 US firms over the period 1981–2008, we provide empirical evidence consistent with these arguments.     

Investment–cash flow sensitivity and investor protection

We examine the role of country-level legal investor protection (i.e., shareholder and creditor protection) on firm investment–cash flow sensitivity (ICFS). Using underexplored research data on investor protection across 21 countries and working with a conservative empirical design, we extend prior literature on the relation between investor protection and ICFS and provide new evidence on how these country-level attributes interact to explain a firm's ICFS. We find that either the strong legal protection of minority shareholders or the strong legal protection of creditors reduces the sensitivity of investment to internal cash flow. However, in countries with strong levels of both minority shareholder and creditor protection, ICFS increases. Our results remain robust after controlling for several alternative explanations. The results support the argument that overregulation arises when policymakers increase investor protection at levels that lead firms to avoid external sources of finance, hampering firm investment. Our findings suggest that countries face a regulatory trade-off such that increasing investor protection (either shareholder or creditors protection) enhances financial markets efficiency, but excessive regulation can indeed lead to financial markets inefficiencies.     

What drives investment–cash flow sensitivity around the World? An asset tangibility Perspective

Motivated by ongoing debates on investment–cash flow sensitivity (ICFS) and its documented decline and disappearance in the U.S., we investigate the determinants of ICFS. Using firm-level data across 41 countries for the 1993–2013 period, we document an important role of asset tangibility in explaining the patterns in ICFS. Asset tangibility affects ICFS through two channels: investment intensity and cash flow persistence. As the share of tangible capital, investment and cash flow persistence has fallen in developed economies, ICFS has declined. In contrast, as developing economies operate with more tangible capital, have higher investment rates and more persistent cash flows, their ICFS is more stable. The results support our explanation of ICFS as a reflection of capital (investment) intensity and income predictability, rather than a measure of financial constraints.     

The effect of banking system reform on investment–cash flow sensitivity: Evidence from China

This study investigates the effect of banking system reform on the investment behavior of Chinese listed firms. We find that the politically-oriented investment problem for state-controlled listed companies is mitigated by the reform due to foreign participation in the management of Chinese banks. The problem of underinvestment in non-state-controlled listed companies also appears to be alleviated due to an increase of bank loans. We include leverage in our analysis and the main findings are robust. The results provide evidence that Chinese banking system reform has increased the efficiency of resource allocation, easing investment distortions in state-controlled listed companies and reducing financial constraints in non-state-controlled listed companies.     

Banking system reform and investment–cash flow relation: Case of a small transition economy

This research examines the effect of banking system reform which is measured by foreign bank's presence on investment–cash flow relation in a context of a small transition economy. The U-shape relation between investment and cash flow is found. We also find evidence that the presence of foreign banks in Vietnam results in decreasing in dependence on local banks and has changed corporate investment behaviors. Company investments are less reliant on internal cash flow in the post reform period. Although overinvestment of state controlled firms is not reduced but underinvestment problem of non-state-controlled listed firms is mitigated due to better accessibility to bank loans. The investigated relation between investment and leverage is robust for this conclusion.     

Does financing influence the sensitivity of cash and investment to asset tangibility?

Research shows that asset tangibility substantially impacts firms’ cash levels and investment. Using the deregulation of equity issuance in the U.S. as an exogenous shock to access to equity markets, we investigate the influence of financing on the dependence of cash and investment on asset tangibility. We show that financing dampens the sensitivity of cash and investment to asset tangibility, and promotes investment and firm growth. Our results suggest that greater access to financing allows financially constrained firms to invest in productive projects that may otherwise not be taken up. This provides evidence that public firms even in well-developed financial markets such as the U.S. benefit from financial deregulation that removes barriers to external financing, shedding light on the role of financial markets in fostering growth.     

Is the relationship between investment and conditional cash flow volatility ambiguous,asymmetric or both?

We investigate the effect of cash flow volatility on investment. Our evidence suggests that financially constrained firms decrease investment (i) when experiencing persistently high volatility; (ii) when experiencing both high volatility and negative cash flow growth realisations; and (iii) when holding low cash levels and experiencing both high volatility and a negative cash flow growth realisations. In financially unconstrained firms, the above effects are either not found or are of relatively low economic importance. Overall, our findings lend support to the financial flexibility literature and tend to contradict predictions of the real options literature.     

Information asymmetry,east–west cultural differences,and divergence in investor reactions

This paper investigates the divergence in investor behaviour between the United States and China following the abolition of the Chinese presidential term limit in 2018, which may, in part, have reflected the heterogeneous opinions expressed in public online media regarding this event. Compared with Chinese investors, the sentiment among US investors was considerably more pessimistic. Accordingly, we find that Chinese companies listed in the United States significantly underperformed relative to a sample of propensity score-matched firms listed in China. Additionally, we find that the political connectedness of firms to the Chinese government strongly influenced the stock prices of US-listed Chinese firms.     

Does cash flow predict returns?

In this paper, we propose the hypothesis that cash flow and cash flow volatility predict returns. We categorize firms listed on the New York Stock Exchange into sectors, and apply tests for both in-sample and out-of-sample predictability. While we find strong evidence that cash flow volatility predicts returns for all sectors, the evidence obtained when using cash flow as a predictor is relatively weak. Estimated profits and utility gains also suggest that it is cash flow volatility that is more relevant as a source of information than cash flow.     

Are analysts' cash flow forecasts useful?

This study provides evidence that the cost of equity capital decreases with the number of analysts who issue both cash flow and earnings forecasts (cash analysts). The evidence also shows that cash analysts reduce information asymmetry and predict long‐term earnings more accurately than analysts who issue only earnings forecasts. Taken together, these findings suggest that cash analysts provide market participants with high‐quality information and, as a result, firms benefit from cash analyst coverage in the form of a reduced cost of equity capital.     

Is investment–cashflow sensitivity a good measure of financial constraints?

Since Fazzari et al. (1988), investment–cashflow sensitivity has been one of the most important indicators for testing and measuring the external financial constraints of corporations. This study analyzes the effect of changes in the relative cost of internal and external financing on investment decisions in response to tax changes. China’s 2004 VAT reform decreased companies’ effective tax rates, leading to an increase in operating cashflow. This, in turn, reduced the internal cost of financing and the value of the tax shield and increased the cost of debt financing. This study shows that in the case of the VAT reform, investment–cashflow sensitivity increased significantly, whereas cash holdings–cashflow sensitivity and borrowing-slack sensitivity did not significantly change. We conclude that investment–cashflow sensitivity is not an effective measure of financial constraints under information asymmetry, but cash–cashflow sensitivity and borrowing-slack sensitivity may be useful alternatives.     

The effects of operating cash flow disclosure on earnings comparability,analysts' forecasts,and firms’ investment decisions during the Pre-IFRS era

We examine the effects of the availability of operating cash flow (OCF) information disclosed by firms operating in 15 international countries during the pre-IFRS era on: (1) the comparability of these firms' disaggregated earnings to those of U.S. firms for equity valuation purposes, (2) the properties of analysts' earnings forecasts, and (3) the efficiency of firms' investment decisions. We find that the comparability of disaggregated earnings improves after company-disclosed OCF information is available. We also find decreases in analysts' forecast errors and dispersion and a decrease in firms’ tendency to over- or under-invest when they are predisposed to do so.     

Information asymmetry,leverage and firm value: Do crisis and growth matter?

Drawing on pecking order and agency cost theories, we assess the extent to which information asymmetry is an important determinant of firm value and the extent to which this relationship is conditional on the leverage level of firms. We also assess the impact of information asymmetry on firm value during the pre and post 2007/09 financial crisis period and for high and low growth opportunity firms. Using a large sample of UK firms, our empirical findings suggest that information asymmetry adversely impacts firm value, and that this effect decreases with firm's leverage. We also find that leverage has a negative effect on firm value, and that the marginal effect of leverage is lower for information asymmetric firms. Further, we find that the relation between information asymmetry and firm value is more pronounced in the post-crisis period than the pre-crisis period. Finally, we show that the impact of information asymmetry on firm value is higher (lower) for firms with high (low) growth opportunities.     

Do bank managers signal through cash flow statements?

We empirically examine the cash flow statements for Japanese banks and whether their managers engage in classification shifting to temper concerns about risk exposure. To create a buffer against liquidity shocks, they shift cash flows from investing and/or financing activities to operating activities. We also find robust evidence that classification shifting intensifies in higher risk situations. Although prior research on managerial discretion focuses on earning management, we are the first to show cash flow management to avoid sequential negative changes in operating cash flows. We show that these activities convey valuable information about changes in banks' risk exposure.     

CEO prior uncertainty and pay–performance sensitivity

A CEO's pay–performance sensitivity (PPS) is higher in the first year of their tenure than in the following years. I explain this finding with reference to chief executive officer (CEO) prior uncertainty: Because of information asymmetry and/or uncertainty about the quality of the match between a CEO and a firm, first-year compensation is often arranged to depend largely on performance. Consistent with this explanation, CEOs with higher prior uncertainty exhibit higher first-year PPS. Also, PPS is higher for outsider CEOs than insider CEOs. Among outsider CEOs, first-year PPS is lower for former executives of large public firms. An insider CEO's service time in a firm before becoming the CEO reduces first-year PPS.     

Why do firms save cash from cash flows? Evidence from firm‐level estimation of cash–cash flow sensitivities

We construct firm‐level estimates for the cash flow sensitivity of cash (CCFS) by modelling heterogeneous slopes in reduced‐form cash equations. This approach allows identifying firms with a high, low or even negative savings propensity. We find that high CCFS firms have higher income variation, suggesting cash buffering is triggered by income shocks. High CCFS firms do not suffer from financing constraints measured by a wide selection of indicators. Our results suggest that the CCFS is not an adequate indicator to capture financing constraints. Rather, a higher CCFS indicates smoothing of income fluctuations by installing a cash buffer that successfully prevents future income shortfall.     

Optimal consumption and investment with Epstein–Zin recursive utility

We study continuous-time optimal consumption and investment with Epstein–Zin recursive preferences in incomplete markets. We develop a novel approach that rigorously constructs the solution of the associated Hamilton–Jacobi–Bellman equation by a fixed point argument and makes it possible to compute both the indirect utility and, more importantly, optimal strategies. Based on these results, we also establish a fast and accurate method for numerical computations. Our setting is not restricted to affine asset price dynamics; we only require boundedness of the underlying model coefficients.     

Spring-loading future performance when no one is looking? Earnings and cash flow management around acquisitions

We find evidence that performance—reflected in earnings and cash flows—is transferred from targets to acquirers around acquisitions. Using a sample of 2128 completed deals from 1985 to 2010, our results suggest that targets depress performance when investor attention declines once the deal parameters are set, and much of that performance understatement is transferred to boost post-acquisition acquirer performance. Evidence of variation across subsamples provides additional confirmation: transfers are more visible for large deals (with transfers large enough to be detected) and muted for pooling transactions (with lower incentives to transfer). We contribute to the earnings management literature by showing that earnings and cash flows are transferred not just within firms but also across firms, and to the mergers and acquisitions literature by documenting that performance is managed not only before but also after deals are announced.     

Do shareholders punish or reward excessive CSR engagement? Moderating effect of cash flow and firm growth

Although extensive past research has studied the connection between corporate social responsibility (CSR) and firm value, it has rarely discriminated between optimal and excessive CSR. Thus, we addressed this issue by examining whether shareholders punish or reward excessive CSR engagement through the moderating effect of cash flow and firm growth. We applied country–industry–year fixed-effects (FE) regression to a cross-country sample of 43,803 firm-year observations between 2002 and 2019. The findings show that while both optimal and excessive CSR increase firm value, optimal CSR has greater value relevance than excessive CSR for shareholders. However, although cash flow positively moderates the relationship between optimal and excessive CSR and firm value, firm growth negatively moderates this relationship. The findings are robust regarding alternative CSR proxies, industry-adjusted firm value measures, public governance indicators, and endogeneity concerns.