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Internal Finance and Corporate Investment

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  • Kholdy, Shady
  • Sohrabian, Ahmad

Abstract

This paper examines Pecking Order/Free Cash Flow behavior in small ($25-50 million), medium ($100-250 million), and large ($1000 million and over) firms. The purpose is to proffer an explanation for the important role of cash flow on the investment expenditure of firms that is more complete than the commonly given accounts. The Pecking order theory (PO) emphasizes the value-enhancing influence of cash flow, while the free cash flow hypothesis (FCF) underscores its value-destroying effect. Using the vector error correction model, we find that although the overall behavior of small firms support the pecking order theory, the cash flow of these firms does not have any causal effect on their investment. We further find evidence of free cash flow theory in large firms. Copyright 2001 by MIT Press.

Suggested Citation

  • Kholdy, Shady & Sohrabian, Ahmad, 2001. "Internal Finance and Corporate Investment," The Financial Review, Eastern Finance Association, vol. 36(2), pages 97-113, May.
    • Handle: RePEc:bla:finrev:v:36:y:2001:i:2:p:97-113
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