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Investment–cash flow sensitivity and investor protection

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  • Luiz Ricardo Kabbach‐de‐Castro
  • Henrique Castro Martins
  • Eduardo Schiehll
  • Paulo Renato Soares Terra

Abstract

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.

Suggested Citation

  • Luiz Ricardo Kabbach‐de‐Castro & Henrique Castro Martins & Eduardo Schiehll & Paulo Renato Soares Terra, 2023. "Investment–cash flow sensitivity and investor protection," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 50(7-8), pages 1402-1438, July.
    • Handle: RePEc:bla:jbfnac:v:50:y:2023:i:7-8:p:1402-1438
    DOI: 10.1111/jbfa.12645
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