Financial Development and Investment-Cash Flow Sensitivity

Economic theory posits that financial development eases firm level financing constraints by mitigating information asymmetry and contracting imperfections. This paper empirically tests for this notion by using firm level data from selected African countries. The sampled firms show positive and significant investment cash flow sensitivity coefficients indicating they are financially constrained. Financial development is found to have a significant and negative effect on the estimated cash flow sensitivity coefficients indicating it reduces firm financial constraints. The result further shows that such positive role of financial development is attributed to financial intermediary development and not to stock market development. A unique result to the African reality is that even firms in countries with high level of financial development are financially constrained. This implies the financial development in Africa is too weak and more policy attention is needed in this regard.

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Alternative measure of financial development and investment-cash flow sensitivity: evidence from an emerging economy

Financial Innovation ◽

10.1186/s40854-018-0118-9 ◽

2019 ◽

Vol 5 (1) ◽

Cited By ~ 9

Author(s):

Gaurav Gupta ◽

Jitendra Mahakud

Keyword(s):

Financial Development ◽

Cash Flow ◽

Emerging Economy ◽

Alternative Measure ◽

Flow Sensitivity ◽

Cash Flow Sensitivity

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The Effect of Financial Development on the Investment-Cash Flow Relationship: Cross-Country Evidence from Europe

The B E Journal of Economic Analysis & Policy ◽

10.2202/1935-1682.2302 ◽

2010 ◽

Vol 10 (1) ◽

Cited By ~ 16

Author(s):

Bo Becker ◽

Jagadeesh Sivadasan

Keyword(s):

Financial Markets ◽

Financial Development ◽

Cash Flow ◽

Set Covering ◽

Firm Level ◽

Data Set ◽

Flow Sensitivity ◽

Cash Flow Sensitivity ◽

Cross Country ◽

Financial Environment

Abstract We investigate if financial development eases firm level financing constraints in a cross-country data set covering much of the European economy. The cash flow sensitivity of investment is lower in countries with better-developed financial markets. To deal with potentially serious biases, we employ a difference-in-difference methodology. Subsidiaries of other firms have access to internal capital markets and hence depend less on the external financial environment. As predicted, the benefit of financial development is smaller in subsidiary firms. This shows that financial development can mitigate financial constraints, and sheds light on the link between financial and economic development.

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Financial Development and the Cash Flow Sensitivity of Cash

SSRN Electronic Journal ◽

10.2139/ssrn.873145 ◽

2005 ◽

Author(s):

Inder K. Khurana ◽

Xiumin Martin ◽

Raynolde Pereira

Keyword(s):

Financial Development ◽

Cash Flow ◽

Flow Sensitivity ◽

Cash Flow Sensitivity

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Financial Development and the Cash Flow Sensitivity of Cash

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109000002647 ◽

2006 ◽

Vol 41 (4) ◽

pp. 787-808 ◽

Cited By ~ 117

Author(s):

Inder K. Khurana ◽

Xiumin Martin ◽

Raynolde Pereira

Keyword(s):

Financial Development ◽

Cash Flow ◽

Financial Constraints ◽

Cash Holdings ◽

Cash Flows ◽

External Financing ◽

Firm Level ◽

Investment Projects ◽

Flow Sensitivity ◽

Cash Flow Sensitivity

AbstractPrior research posits that market imperfections and the lack of institutions that protect investor interests create a divergence between the cost of internal and external funds, thereby constraining firms' ability to fund investment projects through external financing. Financial constraints force firms to manage their cash flows to finance potentially profitable projects. A related stream of research documents that financial constraints due to costly external financing are more pronounced in underdeveloped financial markets. We examine the influence of financial development on the demand for liquidity by focusing on how financial development affects the sensitivity of firms' cash holdings to their cash flows. Using firm-level data for 35 countries covering about 12,782 firms for the years 1994–2002, we find the sensitivity of cash holdings to cash flows decreases with financial development. We also consider additional implications of firms' cash flow sensitivity of cash with respect to firm size and business cycles. Overall, we provide new cross-country evidence of the role of financial development on financial constraints.

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