How Do Firms Allocate Internal Cash Flow? The Effect of Misvaluation and Costly External Financing

61 Pages Posted: 18 Jan 2012 Last revised: 27 Sep 2012

See all articles by Xin (Simba) Chang

Xin (Simba) Chang

Nanyang Business School

Sudipto Dasgupta

Chinese University of Hong Kong, Lancaster University, and CEPR

George Wong

The Hong Kong Polytechnic University

Jiaquan Yao

Jinan University - Management School

Date Written: September 27, 2012

Abstract

We examine the effects of costly external financing and firm misvaluation on the allocation of internal cash flow to corporate investment, cash holdings, and financing activities. In the process, we correct methodological and data errors in a recent paper by Gatchev, Pulvino, and Tarhan (Journal of Finance, Vol. 65, pp. 725-763, 2010). We provide the correct estimates for the cash flow sensitivities, and, in addition, provide new evidence on how firm misvaluation affects the allocation of cash flow. We show that if firms are undervalued, they allocate more cash flow to investment and less to replace costly external finance.

Keywords: Cash flow, misvaluation, catering channel, financial constraints, investment, cash holdings, external finance

JEL Classification: G21, G31, G32

Suggested Citation

Chang, Xin and Dasgupta, Sudipto and Wong, George and Yao, Jiaquan, How Do Firms Allocate Internal Cash Flow? The Effect of Misvaluation and Costly External Financing (September 27, 2012). Available at SSRN: https://ssrn.com/abstract=1987850 or http://dx.doi.org/10.2139/ssrn.1987850

Xin Chang

Nanyang Business School ( email )

S3-B1B-76 Nanyang Avenue
Singapore, 639798
Singapore

HOME PAGE: http://www.ntu.edu.sg/home/changxin

Sudipto Dasgupta (Contact Author)

Chinese University of Hong Kong, Lancaster University, and CEPR ( email )

CUHK, Cheng Yu Tung Building, Room 1224
Shatin, NT
Hong Kong
Hong Kong

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

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