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The impact of cash holdings and external financing on investment-cash flow sensitivity

Author

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  • Tae-Nyun Kim

Abstract

Purpose - – This paper aims to propose several factors which can explain the negative relationship between financial constraints and investment-cash flow sensitivity. Design/methodology/approach - – The author uses traditional fixed effects model and minimum distance panel estimation by Erickson and Whited (2000) to estimate investment-cash flow sensitivity in the cash flow-augmented investment equation. In addition, principal component analysis is used to construct a financial constraints measure. Findings - – First, it was found that substitutability between cash holdings and free cash flow can partially explain why financially constrained firms do not depend on cash flow as heavily as we expect. Second, it was confirmed that the level of net external financing can also partially explain the investment-cash flow sensitivity puzzle. Furthermore, it was argued that the influence of cash holdings and external financing on investment-cash flow sensitivity is caused by the low level of internal cash flow for financially constrained firms. This argument is supported by our findings from an examination of investment-cash flow sensitivity for bank-dependent firms during the recession periods. Originality/value - – This paper contributes to the literature by suggesting possible partial explanations for the contradictory relationship between investment-cash flow sensitivity and financial constraints.

Suggested Citation

  • Tae-Nyun Kim, 2014. "The impact of cash holdings and external financing on investment-cash flow sensitivity," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 13(3), pages 251-273, August.
    • Handle: RePEc:eme:rafpps:v:13:y:2014:i:3:p:251-273
    DOI: 10.1108/RAF-09-2012-0080
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    Citations

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    Cited by:

    1. Abdul Rashid & Noshaba Jabeen, 2018. "Financial frictions and the cash flow – external financing sensitivity: evidence from a panel of Pakistani firms," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 4(1), pages 1-20, December.
    2. Claudiu Tiberiu Albulescu, 2020. "Investment Behaviour and Firms’ Financial Performance: A Comparative Analysis Using Firm-Level Data from the Wine Industry," International Journal of Management, Knowledge and Learning, International School for Social and Business Studies, Celje, Slovenia, vol. 9(1), pages 75-94.
    3. Abdolhossein Talebi Najafabadi* & Zahra Farhadi & Narjes Kamali Kermani, 2018. "The Relationship Between Social Responsibility and Investment-Cash Flow ?Sensitivity ? and the Role of Agency Costs," The Journal of Social Sciences Research, Academic Research Publishing Group, vol. 4(11), pages 294-302, 11-2018.
    4. Ilker Yilmaz, 2022. "Leverage and Investment Cash Flow Sensitivity: Evidence from Muscat Securities Market in Oman," SAGE Open, , vol. 12(3), pages 21582440221, August.

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