Investment-cash flow sensitivity

Topics: Cash flow, Corporate finance, Investment Pages: 22 (5184 words) Published: October 27, 2013
CORPORATE LIQUIDITY, CASH FLOW SENSITIVITY, AND INVESTMENT DECISION

Written by:
Destria Kurnianti
10/309731/PEK/15164

Ratified on 18 Januari 2012
Supervisor

Prof. Marwan Asri, MBA, Ph.D
INTRODUCTION
Modigliani and Miller (1958), in a perfect market conditions there is no relationship between investment decisions and financing decisions. Although the assumption of perfect markets is eliminated, the separation between investment decisions and financing decisions still occur even if there is a slight modification that the manager must use the cost of capital as the weighted average discount rate (Hidayat, 2009). Even when the capital structure has become irrelevant, either because of taxes or because of other factors, still did not occur a direct relationship between investment and financing. Things that should be done by a manager is that the investment program is decided first and then decide its funding so that investment decisions are actually intended to make the AKS imalkan value of the company, therefore, investment decisions should be independent of funding decisions. Some empirical evidence suggests an association between investment decisions and financing decisions, in other words there is a correlation between the level of corporate liquidity and level of investment in many companies. Several previous studies Fazzari, Hubbard, and Petersen (1988); Vogt (1994); Kaplan and Zingales (1997); Cleary (1999); Moyen (2004); Almeida, et al (2004), and Hidayat (2009) show that there is a positive relationship between liquidity and investments decision in companies in the United States. The same was found by Hoshi, et al (1991) in Japan, Chirinko and Schaller (1996); Chirinko and Kalckreuth (2002); Bruinshoofd (2003); Mizen and Varmeulen (2005) and Prasetyantoko (2007). Empirical evidence in Indonesia is shown by Agung (2000), Kristianti (2003), Hermeindito (2004), and Hidayat (2009) who finds that liquidity is positively related to investment decisions. Instead Prasetyantoko (2007) show that liquidity is negatively related to investment decisions. In his research, Prasetyantoko (2007) use cash flow as a proxy for liquidity, while investment is measured by capital expenditure is deflated by the capital stock. Investment cash flow sensitivity is defined as the level of the company's financial constraints. Cash flow sensitivity of investment reflects higher cost of external financing relative to internal financing due to asymmetric information or agency problem. Other studies show a relationship between cash flow sensitivity and financing constraints are sensitive to how the company is classified into two groups who are financially constrained and non financially constrained. Fazzari et al (1988) stated that in addition to the opportunity to grow, investment companies as well affect the company's cash flow and more will further reduce the company's dividend payment. Hovakimian and Hovakimian (2005) concluded that there is a positive relationship between internal funds and investment decisions due to the liquidity constraints faced by firms as a result of the gap between the cost of external financing and internal financing. The results Alti (2003) showed that the relationship between investment and cash flow is stronger in companies that are in growth stage, which is likely to experience financial difficulties because the companies have to make adjustments between the investments made ​​with generated cash flow. Moreoever it reflects the company's growth opportunities. Based on previous studies, researchers can estimate the life cycle of the company's cash flow sensitivity of investment and use it to classify firms into groups with high cash flow sensitivity, low, and negative. Hovakimian (2009) explains that firms with positive cash flow sensitivity will face higher cost of external financing than the companies who have insensitive cash flow. Companies with positive cash flow...

References: Agung, Juda (2000), Financial Constraint, Firms » Investment and the Channels of Monetary Policy in Indonesia , Apllied Economics, 32: pp. 1637-1646.
Almeida, Heitor, Campello, Murillo, and Weisbach, Michael S. (2004), The cash Flow Sensitivity of Cash , Journal of Finance, vol. LIX, no. 4: pp. 1777-1804.
Arifin, Zaenal, (2005), Teori Keuangan dan Pasar Modal, Yogyakarta: Ekonosia.
Brigham, Eugene F. and Ehrhardt, Michael C. (2005), ∆Financial Management: Theory and Practice∆ 11th Edition, Thomson, South-Western.
Brigham, EF, Gapenski, LC, and Daves, PR (1999), Intermediate Financial Management , 6th Edition, The Dryden Press, Harcourt Brace College Publishers.
Chan, LK and Ch en, N. (1991), Structural and Return Characteristics of Small and Large Firms , Journal of Finance, 46: pp. 1467-1484.
Chung, KH and Charoenwong, C. (1991), Investment Options, Assets in Place, and the Risk of Stocks , Financing Management, Autumn: pp. 21-33.
Cleary, Sean (2004), International Corporate Investment and the Role of Financial Constraint , Saint Mary»s University Working Paper.
Cleary, Sean (1999), The Relationship between Firm Investment and Financial Status , Journal of Finance, vol. LIV no. 2: pp. 673-692.
Fama, Eugene F. (1974), The Empirical Relationship Between the Dividend and Investment Decisions of Firms , American Economic Review, 76: pp. 323-329.
Fama, Eugene F. and French, Kenneth R. (2000), Testing Tradeoff and Pecking Order Predictions about Dividents and Debt , The Center for Research in Security Price Working Paper No. 506.
Fama, Eugene F. and French, Kenneth R. (1992), The Cross-Section of Expected Stock Returns , Journal of Finance, 47: pp. 427-465.
Fazzari, Steven M., Hubbart, Glenn R., and Petersen, Bruce C. (1988), Financing Constrains and Corporate Investment , Brooking Papers on Economic Activity, 19: pp. 141-195.
Fazzari, Steven M., Hubbart, Glenn R., and Petersen, Bruce C. (1988), “Financing Constrains and Corporate Investment” , Brooking Papers on Economic Activity, 19: pp. 141-195.
Fitria, Weny. (2002), “Arus Kas, Kendala Pendanaan, Mispricing, dan Investasi: Studi Empiris pada Bursa Efek Indonesia”. Tesis Program Pasca Sarjana (Magister Sains), Fakultas Ekonomi dan Bisnis Universitas Gadjah Mada, Tidak dipublikasikan.
Hidayat, Riskin. (2009), “Keputusan Investasi dan Financial Constraint: Studi Empiris pada Bursa Efek Indonesia”. Tesis Program Pasca Sarjana (Magister Sains), Fakultas Ekonomi dan Bisnis Universitas Gadjah Mada, Tidak dipublikasikan.
Hoshi, Takeo, Kashyap, Anil K., and Scharfstein, David, (1986), Corporate Structure Liquidity and Investment: Evidence from Japanese Panel Data , Quarterly Journal of Economics, 106: pp. 33-60.
Hovakimian, Gayane and Titman, Sheridan, (2006), Corporate Investment with Financial Constraints: Sensitivity of Investment to Funds from Voluntary Asset Sales , Journal of Money,Credit, and Banking, 38 (2): pp. 357-374.
Jensen, Michael C. (1986), Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers ,American Economic Review, 76: pp. 323-329.
Jensen, Michael C. and Meckling, WH (1976), Theory of the Firm: managerial Behavior, Agency Costs, and Ownership Structure , Journal of Financial Economics, vol. 3 no. 4: pp. 305-360.
Kallapur, Sanjay and Trombley, Mark A. (1999), The Association Between Investment Opportunity Set Proxies and Realized Growth , Journal of Business and Accounting, April/ May: pp. 505-519.
Kaplan, Steven N. and Zingales, Luigi (2000), Investment-Cash Flow Sensitivities Are Not Valid Measures of Financing Constraints , Quarterly Journal of Economics, May: pp. 707-712.
Kaplan, Steven N. and Zingales, Luigi (1997), Do Financing Constraints Explain Why Investment is Correlated with Cash Flow ?, Quarterly Journal of Economics, 112: pp. 169-215.
Lang, Larry, Ofek, Eli, and Stulz, Rene M. (1996), Leverage, Investment, and Firm Growth , Journal of Financial Economics, 40, pp. 3-29.
Mustafa, Rahman Dano. (2009), “Turbulensi Perekonomian dan Determinan Nilai Tukar Rupiah Periode 1990.I – 2008.IV”. Tesis Program Pasca Sarjana (Magister Sains), Fakultas Ekonomi dan Bisnis Universitas Gadjah Mada, Tidak dipublikasikan.
Modigliani, Franco and Miller, Merton, H. (1958), The Cost of Capital, Corporation Finance, and the Theory of Investment , American Economics Review, 48: pp. 461-297.
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Cash Flow and Growth Rate Essay
  • Bonds: Bond and Cash Flow Essay
  • Cash Flows Essay
  • Cash Flow Essay
  • Cash Flow Essay
  • Cash Flow Essay
  • Cash Flows Essay
  • Cash flow Research Paper

Become a StudyMode Member

Sign Up - It's Free