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Finance Constraints or Free Cash Flow? The Impact of Asymmetric Information on Investment

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  • Robert E. Carpenter

    (Emory University)

Abstract

Two explanations characterize the nature of information asymmetries in corporate investment-financing decisions. Models based on finance constraints argue that information-driven cost differentials between internal and external finance may leave profitable investment projects unexploited. Models based on the agency costs of free cash flow suggest that managers increase their utility by wasting resources on unprofitable investments. This paper uses firm-level panel data to empirically compare a model of asymmetric information motivated by finance constraints against the free cash flow alternative by examining the response of firms' investment to changes in internal and external finance. The findings suggest that both finance constraints and agency costs are present in the capital markets.

Suggested Citation

  • Robert E. Carpenter, 1994. "Finance Constraints or Free Cash Flow? The Impact of Asymmetric Information on Investment," Finance 9401001, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:9401001
    Note: 29 pages of text, data appendix, 5 tables on 4 pages are contained in a separate file. Files are word for windows binary.
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    References listed on IDEAS

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    Cited by:

    1. Alfredo Bobillo & Juan Rodriguez Sanz & Fernando Tejerina Gaite, 2009. "Investment Decisions, Liquidity, and Institutional Activism: An International Study," Journal of Business Ethics, Springer, vol. 87(1), pages 25-40, April.

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    • G - Financial Economics

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