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

Abstract

This paper uses a large panel of Pakistani non-financial firms over the period [2000][2001][2002][2003][2004][2005][2006][2007][2008][2009][2010][2011][2012][2013] to examine the role of financial constraints in establishing the relationship between cash flow and external financing. The results reveal that there exists a negative and significant relationship between external financing and cash flow. The finding of the substitutionary relation between internal funds availability and external financing has been viewed as evidence supporting the pecking order theory of capital structure. Yet, we show that this negative relationship is weak in case of financially constrained firms. We also analyze how credit multiplier affects external financing decisions of financially constrained and unconstrained firms. The results show that for financially unconstrained firms, the negative sensitively of external financing increases with asset tangibility. However, for financially constrained firms, the negative sensitivity of external financing to cash flow either decreases or turns positive as the tangibility of assets increases. This finding implies that financially constrained firms benefit more from investing in tangible assets because such assets not only help relax financial constraints but also having a potential to be a direct source of funds in periods of negative cash flow shocks.

Financial leverage, debt maturity, future financing constraints and future investment

“…Moreover, as far as in an imperfect market, financing strategies are not independent of investment decisions (Rashid and Jabeen, 2018); we believe that the paradoxical findings of previous studies on the relation between FL and future investment also stem from the diversification of STD to LTD ratio. Aivazian and Santor (2008), Umutlu (2010), Jiming et al (2010), Bao (2010), Kannadhasan (2014), Phan (2018), Kalemli-Ozcan et al (2018) and Gebauer et al (2018) showed that FL is inversely related to future investment, but Bae (2009), John andMuthusamy (2011), Flynn (2017) and Luo et al (2018) predicted that FL increases future investment.…”

MandA Likelihood: Impact of Firm Characteristics

“…Firms with a high ratio of tangible assets may involve in investment related to productivity. Moreover, some studies [38,39] argue that firms tend to invest in tangible assets to relax financial constraints and shift over time from tangible assets to investment in intangible and liquid assets. Thus, there is potential influence for tangible assets on the investment decision in form takeovers.…”

Financial Constraints and Cost of Equity: Empirical Study of Shariah Compliant Firms in Indonesia

“…The theoretical framework of pecking order theory (Myers and Majluf, 1984) states that financial friction results in limited or can prevent companies from attracting funding through external sources. This situation can be influenced by various factors, such as taxation, information asymmetry (between lenders and borrowers and / or between managers and shareholders), and transaction costs (Rashid and Jabeen, 2018). Consequently, external funding sources become more expensive or unprofitable, so that in such situations the value of financial flexibility increases or becomes important.…”