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

Tae-Nyun Kim

Review of Accounting and Finance, 2014, vol. 13, issue 3, 251-273

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.

Keywords: Financial constraints; Corporate cash holdings; Investment-cash flow sensitivity (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:v:13:y:2014:i:3:p:251-273

DOI: 10.1108/RAF-09-2012-0080

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