The Impact of Growth Opportunities on the Investment-Cash Flow Sensitivity

Abstract

This paper investigates the relevance of growth opportunities for the interpretation of investment-cash flow sensitivity of large Belgian companies. We use data on both listed and large unlisted firms to better distinguish between issues of overinvestment due to agency problems and underinvestment due to capital constraints. Simultaneously this data set offers opportunities to incorporate a wide variation in levels of asymmetric information. We show that, contrary to what is generally accepted, decreasing cash flow sensitivity as growth prospects improve need not indicate overinvestment. Rather it may indicate that capital constrained firms increase the use of external financing in high growth periods as these financing sources then tend to become more appealing. As a result the dependence of investment decisions on internal financing is diminished, thereby reducing measured cash flow sensitivity below the level of low growth years.

Keywords: Investment decisions, Financing decisions, Financial constraints, Asymmetric information, Stock Listing

JEL Classification: G3, G31, G32