The cash flow–investment relationship: International evidence of limited access to external finance

In efficient and complete financial markets, internal cash flows should have no impact on investment levels; but in inefficient and incomplete markets, the pecking order theory contends that there should be a positive relationship. Further, some studies show that investments of financially constrained firms are more sensitive to internal funds than those of less constrained firms but other studies show the opposite. Using comparable recent data on firms in the four largest industrialized countries (US, UK, Japan, and Germany), this study documents that in all four countries, controlling for the investment opportunity set, investment levels are significantly positively influenced by levels of internal cash flows, indicating that firms face limitation in access to external finance and may operate using a pecking order. Further, international differences in investment level sensitivities to opportunities indicate closer outside monitoring of firms in the bank-centered countries.     

Technology and Financial Development

The growth benefits from financial development are known to vary across industries. However, no systematic effort has been made to determine the technological characteristics shared by industries that grow relatively faster in more financially developed economies. Using the standard growth‐theoretic definition of technology in terms of the production function, we explore a range of technological characteristics that theory suggests might underpin differences across industries in the need or the ability to raise external finance. We find that industries that grow faster in more financially developed countries display greater R&D intensity and investment lumpiness, indicating that well‐functioning financial markets direct resources toward industries where growth is driven by R&D.     

The response of the external finance premium in Asian corporate bond markets to financial characteristics,financial constraints and two financial crises

Empirical investigation of the external finance premium has been conducted on the margin between internal finance and bank borrowing or equities but little attention has been given to corporate bonds, especially for the emerging Asian market. In this paper, we hypothesize that balance sheet indicators of creditworthiness could affect the external finance premium for bonds as they do for premia in other markets. Using bond-specific and firm-specific data for China, Hong Kong, Indonesia, Korea, Philippines, Singapore and Thailand during 1995–2009 we find that firms with better financial health face lower external finance premia in all countries. When we introduce firm-level heterogeneity, we show that financial variables appear to be both statistically and quantitatively more important for financially constrained firms. Finally, when we examine the effects of the 1997–1998 Asian crisis and the 2007–2009 global financial crisis, we find that the sensitivity of the premium is greater for constrained firms during the Asian crisis compared to other times.     

The Relationship between Voluntary Disclosure,External Financing and Financial Status

Using unique Swedish disclosure data from 2007 to 2012, this paper reports three important sets of findings with regard to the relationship between firms’ voluntary disclosure, external financing and financial status. First, financially strong firms disclose more than weaker ones. Second, firms that obtain new financing (equity or debt) disclose more than firms that do not. Third, the association between voluntary disclosure and financing events is stronger in financially weak firms. This last finding is new in the literature. Perhaps financially weak firms that obtain external funding have higher disclosure to counteract contracting and valuation problems in the financial markets.     

Ownership structure and financial constraints: Evidence from a structural estimation

This article examines the impact of the divergence between corporate insiders' control rights and cash-flow rights on firms' external finance constraints via generalized method of moments estimation of an investment Euler equation. Using a large sample of U.S. firms during the 1994-2002 period, we find that the shadow value of external funds is significantly higher for companies with a wider insider control-ownership divergence, suggesting that companies whose corporate insiders have larger excess control rights are more financially constrained. The effect of insider excess control rights on external finance constraints is more pronounced for firms with higher degrees of informational opacity and for firms with financial misreporting, and is moderated by institutional ownership. The results show that the agency problems associated with the control-ownership divergence can have a real impact on corporate financial and investment outcomes.     

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.     

Demand for debt and equity before and after the financial crisis

Supply and demand responses to financial crises result in fluctuations in credit flow to the private sector. Policy makers concerned with the sustainability and growth of viable firms should disaggregate these responses. Utilising firm level data, this study investigates characteristics of firms applying for external finance before and after the financial crisis, along with characteristics of successful applicants. Notwithstanding changes in credit conditions, salient features of external financing demand endure across the period, including ownership, asset structure, age and size. Failure to secure debt in an earlier period does not deter firm owners from applying for loans in a subsequent period. Evidence suggests that the most financially distressed firms are suffering the greatest consequences of the credit crunch.     

Costly external finance,corporate investment,and the subprime mortgage credit crisis

We study the effect of the recent financial crisis on corporate investment. The crisis represents an unexplored negative shock to the supply of external finance for non-financial firms. Corporate investment declines significantly following the onset of the crisis, controlling for firm fixed effects and time-varying measures of investment opportunities. Consistent with a causal effect of a supply shock, the decline is greatest for firms that have low cash reserves or high net short-term debt, are financially constrained, or operate in industries dependent on external finance. To address endogeneity concerns, we measure firms’ financial positions as much as four years prior to the crisis, and confirm that similar results do not follow placebo crises in the summers of 2003–2006. Nor do similar results follow the negative demand shock caused by September 11, 2001. The effects weaken considerably beginning in the third quarter of 2008, when the demand-side effects of the crisis became apparent. Additional analysis suggests an important precautionary savings motive for seemingly excess cash that is generally overlooked in the literature.     

Financial regulation: rising to the challenge

This paper discusses major initiatives from regulation in global financial markets in response to the current crisis. From the perspective of emerging markets a few issues of significance may include: whether shortcomings in innovations in structured financial market products will limit the scope of their development in the emerging markets, and restrict the scope of financial growth? Could more flows be expected to emerging markets from Western banking centres looking for productive opportunities? Are there opportunities for emerging markets finance to invest in good companies with strong balance sheets that are available at relatively cheap valuations. Will the Middle East emerge as a power centre in global finance?     

The role of parent firms in business groups’ internal capital markets

Using a unique dataset of unconsolidated financial statements, we investigate the investment and financing policies of parent firms in South Korea's business groups over the period 2003–2016. Parent firms add to their equity-stake holdings substantially each year to support affiliated firms’ capital expenditures. Parent firms finance their equity-stake investment primarily with external funds. These tendencies are more pronounced if parents sit high in the pyramidal chain or are central to controlling other group firms and if parents belong to large business groups. Overall, parent firms prioritize their role as capital raisers and distributors for affiliated firms, and business groups’ internal capital markets are supported by external finance.     

Conglomerate investment under various capital market conditions

This paper studies the investment of diversified and focused firms under various capital market conditions. When external capital becomes more costly at the aggregate level, investment declines in focused firms but remains unchanged in diversified firms. This investment advantage enjoyed by diversified firms could attribute to both their easy access to external capital and their ability to substitute internal capital markets for costly external markets. Consistent with the internal capital market argument, our findings show that the investment advantage exists for diversified firms even after we control for their easy access to external markets. We also find that the role of internal markets in financing investment is more important for diversified firms that are more financially constrained in external markets. Finally, we find that the segment-level investment becomes more efficient in conglomerates’ internal capital markets under depressed external capital market conditions. Overall, our findings suggest that internal capital allocation functions as a valuable and efficient substitute for diversified firms in a tightened external capital market.     

Firm investment,finance constraint and voluntary asset sales: the evidence from Indian manufacturing firms

This paper examines the importance of finance constraints for firm investment expenditures by looking at the investment-asset sales sensitivity in financially healthy Indian manufacturing firms. Voluntary asset sales is a cleaner indicator of firms' liquidity than cash flows since it is unlikely to influence firms' growth opportunities unless they are financially constrained. We take care of the endogeneity and the implicit monotonicity problems, which are much debated in the literature, by using an endogenous regime switching regression model. We find that the investment-asset sales sensitivity is significantly greater for firms that are likely to be financially constraints.     

External finance and dividend policy: a twist by financial constraints

This study assesses distorting effect of financial constraints on the inverse relationship between internal and external finance by examining impact of an exogenous financing shock (i.e. a regulation released in China in 2008) on dividend policies in a quasi‐natural experimental setting. Our result shows that in the absence of the regulation, the inverse relationship holds. However, the relation is twisted by the 2008 regulation. Compared with unconstrained firms, financially constrained firms are more willing to pay dividends and are more restrained to reduce cash dividends after the regulation, despite the fact that their external financing capacities are further constrained.     

Financial development and innovation: Cross-country evidence

We examine how financial market development affects technological innovation. Using a large data set that includes 32 developed and emerging countries and a fixed effects identification strategy, we identify economic mechanisms through which the development of equity markets and credit markets affects technological innovation. We show that industries that are more dependent on external finance and that are more high-tech intensive exhibit a disproportionally higher innovation level in countries with better developed equity markets. However, the development of credit markets appears to discourage innovation in industries with these characteristics. Our paper provides new insights into the real effects of financial market development on the economy.     

Emerging market corporate leverage and global financial conditions

This paper explores how global financial conditions influence corporate leverage growth in emerging markets (EMs). Using a sample of 800,000 listed and non-listed firms across 28 EMs, we find that accommodative global financial conditions—initially proxied with a measure of U.S. monetary policy—are associated with faster leverage growth. The impact is more pronounced for financially constrained firms, such as small- and medium-sized enterprises (SMEs), and for EMs whose domestic monetary policy is more aligned with that of the United States. The findings suggest that global financial conditions affect EM firms' leverage growth by influencing domestic interest rates and by relaxing corporate borrowing constraints. Finally, leverage increases disproportionately more for firms that are either relatively less profitable or less solvent when global financial conditions become looser.     

The Trade Credit Channel of Monetary Policy Transmission: Evidence from Nonfinancial Manufacturing Firms in Turkey

This study investigates the trade credit channel of monetary policy transmission in Turkey by using a large panel of corporate firms and includes detailed information on balance sheets and income statements of firms that regularly reported to the Central Bank of the Republic of Turkey during the period 1996-2008. The study suggests that the composition of external finance differs considerably across firm types based on size and export performance under tight and loose financial conditions. Small and medium-size manufacturing firms and firms with a low export share are less likely to have access to bank finance, especially in tight periods. In addition, financially constrained firms with limited access to bank finance (small, low-export-share firms) tend to substitute trade credits for bank loans more aggressively in tight periods as monetary policy tightens. The large volume of trade credit on firms' balance sheets and its positive response to contractionary monetary shocks imply that the trade credit channel might subdue the traditional credit channel of monetary transmission.     

Industry conditions,growth opportunities and market reactions to convertible debt financing decisions

Firms that issue convertible debt have high debt- and equity-related costs of external finance. Existing theories of convertible debt finance differ primarily in their identification of the specific causes of the debt- and equity-related costs of external finance. To assess the theoretical issuance motives separately, we propose a simple framework that characterizes how issuers should design convertible debt to efficiently mitigate specific debt- and equity-related costs of external finance. We provide evidence from 588 security offer announcements that supports the hypotheses that: (1) convertible debt can be designed to mitigate different combinations of debt- and equity-related costs of external finance and (2) share price reactions depend on the security design decisions. The results also illustrate that the relations between firm value, financial leverage, investment opportunities, and the rate of future growth are more complex among convertible debt issuers than situations where firms issue standard financial securities.     

Foreign banks and trade

Exploiting unique, time-varying, bilateral data on bank ownership for many countries, we show that exports tend to be larger when a foreign bank from the importing country is present. Entry of a foreign bank also boosts export growth to the home country of the foreign bank relative to other countries, especially when foreign bank presence in the country is large and bilateral cross-border lending low. We find supportive evidence that foreign banks facilitate trade by reducing financial frictions for firms. Entry spurs exports to the foreign bank's home country especially in sectors more dependent on external finance, and particularly so in countries less economically and financially developed and with a higher share of foreign banks. Imports of external finance dependent sectors also grow more after entry, but less so than exports do. Exit of a foreign bank does not fully eliminate the beneficial effects of prior foreign bank presence on exports.     

Do productive firms get external finance? Evidence from Chinese listed manufacturing firms

Due to information asymmetry problem in financial markets good quality firms often find it difficult to prove to external finance providers about their true quality and to distinguish themselves from bad quality firms. We argue that instead of sending indirect signals to financial market good quality firms could focus on improving their productivity to obtain external finance. Besides relying solely on firms' balance sheet information external finance providers using firms' TFP or labour productivity information would have a true knowledge of firms' efficiency and risk. Overall, using a panel of 1591 Chinese listed manufacturing firms between 2003 and 2016 we find that productivity measured by TFP or labour productivity is statistically and economically important and positive in determining firms' external finance, i.e. total leverage, new issue of equity and long-term debt. We find that productivity is helpful for firms to raise new equity finance, but only some weak results for total leverage and long-term debt. Such results hold for both the whole sample and private firm sample. We also find that large and/or old firms and exporting firms are able to make better use of their productivity to gain external finance than their respective counterparts, i.e. small young firms and non-exporting firms. The causality of the regression results is also confirmed by difference-in-difference tests using an exogenous industrial policy shock.     

Investment decisions with financial constraints. Evidence from Spanish firms

This paper analyses to what extent the rejection of the investment dynamics implied by the Euler equation model with quadratic and symmetric adjustment costs can be attributed to the fact that the investment behavior of some firms in some periods is financially constrained by the availability of internal funds. I use a hierarchy of finance model which assumes that internally generated finance for investment is available at a lower cost than external finance, and implies the existence of distinct financial regimes depending on the firm’s financial policy. I estimate the empirical investment equation derived from the model using GMM, taking into account the endogeneity of the selection and allowing for debt finance, imperfect competition and the existence of a possible measurement error in the user cost of capital. The empirical results suggest that the Euler equation model is not seriously misspecified for a sub-sample of firms pursuing a particular financial policy.