Financial Constraints, Mispricing and Corporate Investment

Abstract

This study examines the separate impact and joint effect of financial constraints and financial market mispricing on the sensitivity of investment to internal cash flows. Using a large sample of US manufacturing firms over the period 1971-2004, we find that financially unconstrained firms are more flexible in adjusting their sources of financing for corporate investment in response to financial market mispricing. Specifically, financially unconstrained firms tend to have lower (higher) investment-cash flow sensitivities in situations of overvaluation (undervaluation). This provides an explanation of why unconstrained firms have higher valuations than constrained firms.

Keywords: Financial constraints, Mispricing, Corporate Investment, Investment-cash flow sensitivity, Financial Flexibility

JEL Classification: G31, G32