How Do Misvalued Firms Deploy Internal Cash Flow?

44 Pages Posted: 18 Jan 2012 Last revised: 29 Jun 2022

See all articles by Xin Chang

Xin Chang

Nanyang Business School, Nanyang Technological University

Wing Chun (Kaz) Kwok

The Hang Seng University of Hong Kong

George Wong

The Hong Kong Polytechnic University

Jiaquan Yao

Jinan University - Management School

Date Written: June 29, 2022

Abstract

We examine how firms deploy internal cash flow across primary uses when they are misvalued in capital markets. Our integrated regression framework depicts a complete picture of what firms do with cash flow by jointly estimating the cash flow sensitivities of various uses (i.e., investment, cash holdings, dividends, and external finance reductions). The results show that, given an additional dollar of cash flow, overvalued firms allocate more cash flow to substitute for external financing and less to investment and cash savings. Conversely, undervalued firms shift cash flow away from external finance reductions toward investment and cash savings. When separating external finance into equity and debt, we find that overvalued firms use more cash flow to substitute for equity instead of debt. Collectively, our findings illustrate how firms tune cash flow allocation to absorb the valuation shocks in capital markets and reveal that misvaluation can impact corporate decisions and the real economy through an internal financing channel.

Keywords: Cash flow, misvaluation, market inefficiencies, financial constraints, corporate policies

JEL Classification: G31, G32

Suggested Citation

Chang, Xin and Kwok, Kaz and Wong, George and Yao, Jiaquan, How Do Misvalued Firms Deploy Internal Cash Flow? (June 29, 2022). Nanyang Business School Research Paper No. 21-42, Available at SSRN: https://ssrn.com/abstract=1987850 or http://dx.doi.org/10.2139/ssrn.1987850

Xin Chang (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

HOME PAGE: https://personal.ntu.edu.sg/changxin/

Kaz Kwok

The Hang Seng University of Hong Kong ( email )

Hang Shin Link
Siu Lek Yuen
Shatin, Hong Kong
China

George Wong

The Hong Kong Polytechnic University ( email )

School of Accounting and Finance
Hung Hom, Kowloon, 0
Hong Kong
852 3400 3459 (Phone)
852 2330 9845 (Fax)

Jiaquan Yao

Jinan University - Management School ( email )

No. 601, West Huangpu Road
Guangzhou, Guangdong 510632
China

HOME PAGE: http://www.jiaquanyao.com

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