The Effects of Financial Constraints on Corporate Policies in Australia

Abstract

We jointly study the impact of financial constraints on Australian companies' investment decisions and demand for liquidity. By examining a large sample of Australian firms over the period 1990 to 2003, we find that financial constraints not only reduce the sensitivity of investment to the availability of internal funds, but also increase the responsiveness of cash holdings to internally generated cash flows. Further analysis shows that the impact of financial constraints varies across different cash flow states, i.e., financial constraints have a small effect on corporate investment and cash policies when cash flows are positive. In contrast, the severity of constraints is high in negative cash flow years in which the cost disadvantage of external finance coincides with deteriorating operating performance.

Keywords: Financial Constraints, Cash Policy, Investment-Cash Flow Sensitivity, Cash-Cash Flow Sensitivity, Negative Cash Flow, Australian Firms

JEL Classification: G31, G32