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Investment Policy, Internal Financing and ownership Concentration in the UK

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  • Goergen, M.
  • Renneboog, L.D.R.

    (Tilburg University, Center for Economic Research)

Abstract

This paper investigates whether investment spending of firms is sensitive to the availability of internal funds.Imperfect capital markets create a hierarchy for the different sources of funds such that investment and financial decisions are not independent.The relation between corporate investment and free cash flow is investigated using the Bond and Meghir (1994a) Euler-equation model for a panel of 240 companies listed on the London Stock Exchange over a 6 year period. This method allows for a direct test of the first-order condition of an intertemporal maximisation problem.It does not require the use of Tobin s q, which is subject to mis-measurement problems.Apart from past investment levels and generated cash flow, the model also includes a leverage factor which captures potential bankruptcy costs and the tax advantages of debt.More importantly, we investigate whether ownership concentration by class of shareholder creates or mitigates liquidity constraints.Control is expected to influence the investment financing relation for two reasons.First, due to asymmetric information, the link between liquidity and investment could be a symptom of underinvestment.Firms pass up some projects with positive net present values because of the inflated cost of external funds.Second, from an agency perspective, external funds may not be too expensive but internal funds (free cash flow) may be too inexpensive from the manager s perspective.Whereas high insider ownership concentration reduces the liquidity constraints induced by agency costs, high insider shareholding concentration increases the liquidity constraints in the case of asymmetric information.It is expected that the induced liquidity constraints due to insider ownership is substantially reduced when outside investors control a substantial share stake and have therefore an increased propensity to monitor management.When industrial companies control large shareholdings, there is evidence of increased overinvestment.This relation is strong when the relative voting power (measured by the Shapley values) of the combined equity stakes of families and industrial companies and the Herfindahl index of industrial ownership are high.This suggests that a small coalition of industrial companies is able to influence investment spending.In contrast, large institutional holdings reduce the positive link between investment spending and cash flow relation and hence suboptimal investing.Whereas there is no evidence of over- or underinvesting at low levels of insider shareholding, a high concentration of control in the hands of executive directors creates a positive investment-cash flow relation.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2000-116.

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Date of creation: 2000
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Handle: RePEc:dgr:kubcen:2000116

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Related research

Keywords: corporate governance; investment; corporate ownership; corporate control; liquidity constraints;

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References

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Cited by:
  1. Jaewoon Koo & Kyunghee Maeng, 2006. "Foreign ownership and investment: evidence from Korea," Applied Economics, Taylor & Francis Journals, vol. 38(20), pages 2405-2414.
  2. Pornsit Jiraporn & Pandej Chintrakarn & Jang-Chul Kim & Yixin Liu, 2013. "Exploring the Agency Cost of Debt: Evidence from the ISS Governance Standards," Journal of Financial Services Research, Springer, vol. 44(2), pages 205-227, October.
  3. Perotti, Enrico C & Vesnaver, Luka, 2004. "Enterprise Finance and Investment in Listed Hungarian Firms," CEPR Discussion Papers 4194, C.E.P.R. Discussion Papers.
  4. repec:hal:journl:halshs-00144415 is not listed on IDEAS
  5. repec:hal:cesptp:halshs-00144415 is not listed on IDEAS
  6. Goergen, M. & Renneboog, L.D.R. & Zhang, C., 2008. "Do UK Institutional Shareholders Monitor their Investee Firms?," Discussion Paper 2008-38, Tilburg University, Center for Economic Research.
  7. Renneboog, L.D.R. & Trojanowski, G., 2005. "Control Structures and Payout Policy," Discussion Paper 2005-014, Tilburg University, Tilburg Law and Economic Center.
  8. Crisóstomo, Vicente Lima & López-Iturriaga, Félix Javier & Vallelado González, Eleuterio, 2014. "Nonfinancial companies as large shareholders alleviate financial constraints of Brazilian firm," Emerging Markets Review, Elsevier, vol. 18(C), pages 62-77.
  9. Pascal Nguyen & Nahid Rahman, 2014. "Which Governance Characteristics Affect the Incidence of Divestitures in Australia?," Working Paper Series 180, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  10. Attig, Najah & Cleary, Sean & El Ghoul, Sadok & Guedhami, Omrane, 2012. "Institutional investment horizon and investment–cash flow sensitivity," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 1164-1180.
  11. George, Rejie & Kabir, Rezaul & Qian, Jing, 2011. "Investment-cash flow sensitivity and financing constraints: New evidence from Indian business group firms," Journal of Multinational Financial Management, Elsevier, vol. 21(2), pages 69-88, April.
  12. Pawlina, G. & Renneboog, L.D.R., 2005. "Is Investment-Cash Flow Sensitivity Caused by the Agency Costs or Asymmetric Information? Evidence from the UK," Discussion Paper 2005-23, Tilburg University, Center for Economic Research.
  13. Klaus Gugler, 2003. "Corporate governance and investment," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 10(3), pages 261-289.
  14. Maria-Teresa Marchica, . "Debt Maturity and the Characteristics of Ownership Structure: An Empirical Investigation of UK Firms," Discussion Papers 05/29, Department of Economics, University of York.
  15. Alex Coad, 2007. "Neoclassical vs evolutionary theories of financial constraints : critique and prospectus," Documents de travail du Centre d'Economie de la Sorbonne r07008, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  16. Mueller, Dennis C. & Peev, Evgeni, 2007. "Corporate governance and investment in Central and Eastern Europe," Journal of Comparative Economics, Elsevier, vol. 35(2), pages 414-437, June.
  17. Chen, Alex A. & Cao, Hong & Zhang, Dayong & Dickinson, David G., 2013. "The impact of shareholding structure on firm investment: Evidence from Chinese listed companies," Pacific-Basin Finance Journal, Elsevier, vol. 25(C), pages 85-100.
  18. Francis, Bill & Hasan, Iftekhar & Song, Liang & Waisman, Maya, 2013. "Corporate governance and investment-cash flow sensitivity: Evidence from emerging markets," Emerging Markets Review, Elsevier, vol. 15(C), pages 57-71.
  19. Santiago-Castro, Marisela & Brown, Cynthia J., 2007. "Ownership structure and minority rights: A Latin American view," Journal of Economics and Business, Elsevier, vol. 59(5), pages 430-442.

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