Corporate investment and financial slack: international evidence

Purpose - To address the empirical aspect of corporate investment patterns by providing evidence in an international setting regarding the critical factors affecting firm investment policy, focusing on the relevance of financial factors. Design/methodology/approach - Examines international company‐level data for capital expenditures over the period 1987‐1997 using fixed effects regression analysis. Findings - The capital expenditures of firms that are financially constrained are much less sensitive to the availability of internal funds than unconstrained firms. The evidence is particularly strong when firms are classified according to financial health, but is also prevalent for groups formed according to dividend behavior and firm size. The results provide strong support for the generality of the results of Kaplan and Zingales and Cleary. A major reason for the weak investment‐cash flow sensitivity displayed by unhealthy firms is that they appear to be busy building up financial slack, which has long‐term value, as postulated by Myers and Majluf. Research limitations/implications - The conclusions in this study relate to the investment behavior of firms operating in well‐developed economies, which may not necessarily hold for firms operating in distinctly different environments. Given the critical importance of stimulating investment in developing economies, an interesting topic for future research would be to extend the analysis to firms operating in developing country environments to see whether the results herein also apply in these environments. Originality/value - The results extend empirical evidence to an international setting, providing support for previous US results that had contributed to a debate in the literature. The results also demonstrate that a major reason for the weak investment‐cash flow sensitivity displayed by unhealthy firms is that they are reluctant to invest when debt levels increase, irrespective of the availability of internal funds. This represents an original contribution to the empirical literature.