Hostname: page-component-8448b6f56d-t5pn6 Total loading time: 0 Render date: 2024-04-23T06:24:30.290Z Has data issue: false hasContentIssue false
  • English
  • Français

Financial Development and the Cash Flow Sensitivity of Cash

Published online by Cambridge University Press:  06 April 2009

Inder K. Khurana ,
Xiumin Martin  and
Raynolde Pereira
Inder K. Khurana
Affiliation:
khuranai@missouri.edu, School of Accountancy, College of Business, University of Missouri-Columbia, Columbia, MO 65211.
Xiumin Martin
Affiliation:
xxz55@mizzou.edu, School of Accountancy, College of Business, University of Missouri-Columbia, Columbia, MO 65211.
Raynolde Pereira
Affiliation:
pereirar@missouri.edu, School of Accountancy, College of Business, University of Missouri-Columbia, Columbia, MO 65211.
Get access Rights & Permissions [Opens in a new window]

Abstract

Prior research posits that market imperfections and the lack of institutions that protect investor interests create a divergence between the cost of internal and external funds, thereby constraining firms' ability to fund investment projects through external financing. Financial constraints force firms to manage their cash flows to finance potentially profitable projects. A related stream of research documents that financial constraints due to costly external financing are more pronounced in underdeveloped financial markets. We examine the influence of financial development on the demand for liquidity by focusing on how financial development affects the sensitivity of firms' cash holdings to their cash flows. Using firm-level data for 35 countries covering about 12,782 firms for the years 1994–2002, we find the sensitivity of cash holdings to cash flows decreases with financial development. We also consider additional implications of firms' cash flow sensitivity of cash with respect to firm size and business cycles. Overall, we provide new cross-country evidence of the role of financial development on financial constraints.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 41 , Issue 4 , December 2006 , pp. 787 - 808
Copyright
Copyright © School of Business Administration, University of Washington 2006

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Acemoglu, D.; Johnson, S.; and Robinson, J.. “The Colonial Origins of Comparative Development: An Empirical Investigation.” American Economic Review, 91 (2001), 1369–1401.CrossRefGoogle Scholar
Ali, A., and Hwang., L. “Country-Specific Factors Related to Financial Reporting and the Value Relevance of Accounting Data.” Journal of Accounting Research, 38 (2000), 1–21.CrossRefGoogle Scholar
Almeida, H., and Campello, M.. “Financial Constraints and Investment-Cash Flow Sensitivities: New Research Directions.” Working Paper, New York University and University of Illinois (2002).Google Scholar
Almeida, H.: Campello, M.; and Weisbach, M.. “The Cash Flow Sensitivity of Cash.” Journal of Finance, 59 (2004), 1777–1804.CrossRefGoogle Scholar
Alti, A. “How Sensitive is Investment to Cash Flow When Financing is Frictionless?” Journal of Finance, 58 (2003), 707–722.CrossRefGoogle Scholar
Baumol, W. “The Transactions Demand for Cash: An Inventory Theoretic Approach.” Quarterly Journal of Economics, 66 (1952).CrossRefGoogle Scholar
Beck, T.; Demirguc-Kunt, A.; and Maksimovic, V.. “Financial and Legal Constraints to Growth: Does Firm Size Matter?” Working Paper, University of Maryland (2004).Google Scholar
Beck, T., and Levine, R.. “Bank-Based orMarket-Based Financial Systems: Which is Better?” Journal of Financial Intermediation, 11 (2002), 398–428.Google Scholar
Bekaert, G.; Harvey, C.; and Lundblad, C.. “Does Financial Liberalization Spur Growth?” Working Paper W8245, NBER (2001a).CrossRefGoogle Scholar
Bekaert, G.; Harvey, C.; and Lundblad, C.. “Emerging Equity Markets and Economic Growth.” Journal of Development Economics, 66 (2001b), 466–504.CrossRefGoogle Scholar
Claessens, S., and Laeven, L.. “Financial Development, Property Rights, and Growth.” Journal of Finance, 58 (2003), 2401–2436.CrossRefGoogle Scholar
Cleary, S. “The Relationship between Firm Investment and Financial Status.” Journal of Finance, 54 (1999), 673–692.CrossRefGoogle Scholar
Constantinides, G. “Stochastic Cash Management with Fixed and Proportional Transaction Costs.” Management Science, 22 (1976), 1320–1331.CrossRefGoogle Scholar
David, R., and Brierly, J.. Major Legal Systems in the World Today. London: Stevens and Sons (1985).Google Scholar
Demirguc-Kunt, A., and Maksimovic, V.. “Law, Finance and Firm Growth.” Journal of Finance, 53 (1998), 2107–2131.CrossRefGoogle Scholar
Diamond, D. “Financial Intermediation as Delegated Monitoring, a Simple Example.” Economic Quarterly of the Federal Reserve Bank of Richmond, 82 (1996), 51–66.Google Scholar
Dittmar, A.; Smith, J. M.; and Servaes, H.. “International Corporate Governance and Corporate Cash Holdings.” Journal of Financial and Quantitative Analysis, 38 (2003), 111–133.CrossRefGoogle Scholar
Donaldson, G.Corporate Debt Capacity: A Study of Corporate Debt Policy and Determination of Corporate Debt Capacity. Boston, MA: Division of Research, Harvard Graduate School of Business Administration (1961).Google Scholar
Erickson, T., and Whited, T.. “Measurement Error and the Relationship between Investment and Q.” Journal of Political Economy, 108 (2000), 1027–1057.CrossRefGoogle Scholar
Fazzari, S.; Hubbard, R.; and Petersen, B.. “Financing Constraints and Corporate Investment.” Brookings Papers on Economic Activity, 1 (1988), 141–195.CrossRefGoogle Scholar
Fisman, R., and Love, I.. “Trade Credit, Financial Intermediary Development, and Industry Growth.” Journal of Finance, 58 (2003), 353–374.CrossRefGoogle Scholar
Frenkel, J. A., and Jovanovic, B.. “On Transactions and Precautionary Demand for Money.” Quarterly Journal of Economics, 95 (1980), 25–43.CrossRefGoogle Scholar
Gomes, J. “Financing Investment.” American Economic Review, 91 (2002), 1263–1285.CrossRefGoogle Scholar
Harford, J. “Corporate Cash Reserves and Acquisitions.” Journal of Finance, 54 (1999), 1969–1997.CrossRefGoogle Scholar
Hubbard, R. G. “Capital Market Imperfections and Investment.” Journal of Economic Literature, 36 (1998), 193–225.Google Scholar
Jensen, M. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, 76 (1986), 323–329.Google Scholar
Kaplan, S., and Zingales, L.. “Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?” Quarterly Journal of Economics, 112 (1997), 169–215.CrossRefGoogle Scholar
Keynes, J.The General Theory of Employment, Interest, and Money. London: MacMillan (1936).Google Scholar
Kim, C.; Mauer, D.; and Sherman, A.. “The Determinants of Corporate Liquidity: Theory and Evidence.” Journal of Financial and Quantitative Analysis, 33 (1998), 335–359.CrossRefGoogle Scholar
King, R. G., and Levine, R.. “Finance and Growth: Schumpeter Might be Right.” Quarterly Journal of Economics, 108 (1993), 717–737.CrossRefGoogle Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Legal Determinants of External Finance.” Journal of Finance, 52 (1997), 1131–1150.CrossRefGoogle Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Law and Finance.” Journal of Political Economy, 106 (1998), 1113–1155.CrossRefGoogle Scholar
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A.; and Vishny, R.. “Agency Problems and Dividend Policies around the World.” Journal of Finance, 55 (2000), 1–33.CrossRefGoogle Scholar
Love, I. “Financial Development and Financing Constraints.” Review of Financial Studies, 16 (2003), 765–791.CrossRefGoogle Scholar
Lucas, R. “On the Mechanics of Economic Development.” Journal of Monetary Economics, 22 (1988), 3–42.CrossRefGoogle Scholar
Mayer, C. “Financial Systems, Corporate Finance and Economic Development.” In Information, Capital Markets and Investment, Hubbard, G., ed. NBER (1990).Google Scholar
Miller, M., and Orr, D.. “A Model of the Demand for Money by Firms.” Quarterly Journal of Economics, 80 (1966), 413–435.CrossRefGoogle Scholar
Modigliani, F., and Miller, M.. “The Cost of Capital, Corporate Finance, and the Theory of Investment.” American Economic Review, 48 (1958), 261–297.Google Scholar
Myers, S. “The Capital Structure Puzzle.” Journal of Finance, 39 (1984), 575–592.CrossRefGoogle Scholar
Myers, S., and Majluf, N.. “Corporate Financing and Investment Decisions When Firms Have Information that Investors Do Not Have.” Journal of Financial Economics, 13 (1984), 187–221.CrossRefGoogle Scholar
Opler, T.; Pinkowitz, L.; Stulz, R.; and Williamson, R.. “The Determinants and Implications of Cash Holdings.” Journal of Financial Economics, 52 (1999), 3–46.CrossRefGoogle Scholar
Pinkowitz, L.; Stulz, R.; and Williamson, R.. “Do Firms in Countries with Poor Protection of Investor Rights Hold More Cash?” Working Paper, Georgetown University (2003).CrossRefGoogle Scholar
Poterba, J. “Comment on ‘Financing Constraints and Corporate Investment’.” Brookings Papers on Economic Activity, 1 (1988), 200–204.Google Scholar
Rajan, R., and Zingales, L.. “Financial Dependence and Growth.” American Economic Review, 88 (1998), 559–586.Google Scholar
Reynolds, T., and Flores, A.. Foreign Law: Current Sources of Basic Legislation in Jurisdictions of the World. Littleton, CO: Rothman and Co. (1989).Google Scholar
Robinson, J. “The Generalization of the General Theory.” In The Rate of Interest and Other Essays. London: Macmillan (1952).Google Scholar
Schumpeter, J.The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle, Opie, Redvers, translater. Cambridge, MA: Harvard University Press (1911).Google Scholar
Stein, J. “Agency, Information and Capital Investment.” In Handbook of the Economics of Finance, Constantinides, G., Harris, M., and Stulz, R., eds. Amsterdam: Elsevier Science (2001).Google Scholar
Wurgler, J. “Financial Markets and Allocation of Capital.” Journal of Financial Economics, 58 (2000), 187–214.CrossRefGoogle Scholar