Financial frictions and substitution between internal and external funds in publicly traded Brazilian companies

Abstract

The present study aimed to document the effects of financial constraints on the negative relationship between cash flow and external funds, a phenomenon associated with the Pecking Order Theory. This theory suggests that companies subject to more expensive external funds (financially constrained firms) should demonstrate a stronger negative relationship with cash flow than companies subject to minor financial frictions (financially unconstrained firms). The results indicate that the external funds of constrained firms consistently present less negative sensitivity to cash flow compared with those of unconstrained companies. Additionally, the internal funds of constrained companies demonstrate a positive sensitivity to cash flow, whereas those of unconstrained companies do not show any such significant behavior. These results are in accordance with the findings of Almeida and Campello (2010), who suggest the following: first, because of the endogenous nature of investment decisions in constrained companies, the complementary relationship between internal and external funds prevails over the substitutive effects suggested by the Pecking Order Theory; and second, the negative relationship between cash flow and external funds cannot be interpreted as evidence of costly external funds and therefore does not corroborate the Pecking Order Theory.

Financial frictions and the cash flow – external financing sensitivity: evidence from a panel of Pakistani firms

“…Finally, as explained by Almeida & Campello (2010), owing to the endogenous nature of investment for the case of financially constrained firms, the sensitivity of external financing to internally generated funds is less as compared to their financially unconstrained counterparts. Our finding on the negative relation between internal cash flow and external funds for financially constrained firms is consistent with the findings of Almeida & Campello (2010), Gracia & Mira (2014), and Portal et al, (2012). Table 4 displays the results of fixed effects model for the baseline regression model (Eq.…”

“…In order to examine the relationship between external financing and cash flow, we follow Almeida & Campello (2010), Portal et al, (2012), and Gracia & Mira (2014). We consider two different models that enable us to analyze the external financing and cash flow relationship for both financially constrained and unconstrained firms.…”

Estrutura de capital, liquidez de caixa e valor da empresa: estudo de empresas brasileiras cotadas em bolsa

“…Cash holdings follow the inverse tendency, falling when investment needs exceeds retained earnings and growing when the opposite takes place. However, as pointed by Portal, Zani, and da Silva (2012) and Acharya et al (2007), when firms are subject to high external financing costs (constrained firms), internal and external funds are more complementary than substitute forms of financing, so the inverted relation between cash holdings and leverage may not prevail, as cash holdings and cash flows are positively related (a similar discussion to the difficulty to access external financing we did previously).…”

“…However, it is clear that financial markets cannot be defined in such ways. As argued by Portal, Zani, and da Silva (2012), frictions and transaction costs are indeed real constraints that firms must face when choosing their financing strategy. Considering this setup of frictions, transaction costs and asymmetry of information in debt markets, and also building on Harris and Raviv (1991), the choice between debt and equity financing, and the resulting level of leverage might affect firm value.…”

The world financial crisis and the international financing of Brazilian companies

“…Costa, Paz and Funchal (2008) conclude that Brazilian firms that issued ADRs are not financially constrained for a 1995-2007 sample. Portal, Zani and Silva (2012) conclude that external financing by constrained companies is less sensitive to cash flow generation while internal financing is quite sensitive to it for a sample in the 1995-2005 period. The same is not observed for unconstrained companies.…”