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Is Investment-Cash Flow Sensitivity Caused by Agency Costs or Asymmetric Information? Evidence from the UK

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  • Grzegorz Pawlina
  • Luc Renneboog

Abstract

"We investigate the investment-cash flow sensitivity of a large sample of the UK listed firms and confirm that investment is strongly cash flow-sensitive. Is this sensitivity a result of agency problems when managers with high discretion overinvest, or of asymmetric information when managers owning equity are underinvesting if the market (erroneously) demands too high a risk premium? We find that investment-cash flow sensitivity results mainly from the agency costs of free cash flow. The magnitude of the relationship depends on insider ownership in a non-monotonic way. Furthermore, we obtain that outside blockholders, such as financial institutions, the government, and industrial firms (only at high control levels), reduce the cash flow sensitivity of investment via effective monitoring. Finally, financial institutions appear to play a role in mitigating informational asymmetries between firms and capital markets. We corroborate our findings by performing additional tests based on the stochastic efficient frontier approach and power indices." Copyright Blackwell Publishers Ltd, 2005.

Suggested Citation

  • Grzegorz Pawlina & Luc Renneboog, 2005. "Is Investment-Cash Flow Sensitivity Caused by Agency Costs or Asymmetric Information? Evidence from the UK," European Financial Management, European Financial Management Association, vol. 11(4), pages 483-513.
  • Handle: RePEc:bla:eufman:v:11:y:2005:i:4:p:483-513
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    References listed on IDEAS

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    1. Dan S. Felsenthal & Moshé Machover, 1998. "The Measurement of Voting Power," Books, Edward Elgar Publishing, number 1489.
    2. Correia da Silva, Luis & Goergen, Marc & Renneboog, Luc, 2004. "Dividend Policy and Corporate Governance," OUP Catalogue, Oxford University Press, number 9780199259304.
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