Unexpected investment, tunnelling and financial constraints

Purpose - Based on a sample of 1,435 Vietnamese listed firms over the period from 2005 to 2017, this study examines the sensitivity of unexpected investment to free cash flow and its mechanism. Design/methodology/approach - We tested three hypotheses using two-step system-GMM to investigate investment–cash flow sensitivity for various firm scenarios while accounting for confounding variables. Findings - Firms with negative free cash flow are more likely to engage in underinvestment; conversely, overinvestment is found primarily in firms with positive free cash flow. In terms of the mechanism, while underinvesting decisions are caused mainly by financial constraints, overinvesting behaviour primarily resulted from agency problems, typically in the form of principal-principal conflicts. Interestingly, under the impact of negative cash flow observations, financial constraints tend to decrease investment–cash flow sensitivity. Conversely, the agency costs hypothesis reveals that agency problems are more likely to increase investment–cash flow sensitivity. Originality/value - These findings not only contribute to the current corporate literature but also provide some important practical implications for stock market investors, corporate managers, and policy-setting bodies, specifically in the Vietnamese market.