Ownership structure and investment-cash flow sensitivity
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Ownership structure and investment-cash flow sensitivity Imen Derouiche1 • Majdi Hassan2 • Sarra Amdouni2
Ó Springer Science+Business Media New York 2017
Abstract This study investigates the effect of ownership structure on the use of cash flow in financing corporate investments—the investment-cash flow sensitivity—in a concentrated ownership context. Using a sample of 6797 French listed firms from 2000 to 2013, results show that investment-cash flow sensitivity decreases with the cash-flow rights of the controlling shareholder and increases with the separation of its cash-flow and control rights (excess control rights). Firms are, thus, less likely to use cash flow in investments when the interests of controlling shareholders are aligned with those of minority shareholders. However, they appear to use considerable internal funds for their investments when they have severe agency problems, driven by excess control rights of the controlling shareholders. Overall, our findings help advance the understanding of the role of agency relationship in shaping corporate financial policy. Keywords Ownership structure Excess control rights Investment-cash flow sensitivity JEL Classification G32 G34 M41
1 Introduction Modigliani and Miller (1958) demonstrate that, under perfect market assumptions, firms’ financing policies are irrelevant to their investment decisions. This suggests that optimal investment decisions depend merely on the availability of investment & Imen Derouiche [email protected] 1
Unite´ de recherche CREA, University of Luxembourg, Luxembourg, Luxembourg
2
DEFI, ESSEC Tunis, Tunis, Tunisia
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opportunities, since internal funds and external funds are perfect substitutes. However, the existence of financial market imperfections can create differential cost between internal and external finance, causing investment distortions.1 On the one hand, the presence of asymmetric information increases the cost of external financing, leading to more reliance on internally generated funds (Myers and Majluf 1984). This suggests that external and internal funds are unlikely substitutes and supports the pecking order theory predicting that internal funds are used at the firstbest level in investments, implying a positive investment–cash flow sensitivity. On the other hand, Jensen (1986) and Stulz (1990) argue that contracting problems may lead owner-managers to opportunistically divert free cash flow in negative net present value projects and in the consumption of excessive perquisites. More particularly, insiders of firms with low investment opportunities may prefer obtaining pecuniary and non-pecuniary private benefits of overinvestment rather than disgorging unallocated cash to shareholders. The free cash flow may also be used to finance diversification in segments with poor investment opportunities, thus exacerbating agency costs (Jensen and Meckling 1976). Moreover, the availability of free cash flow may limit the recourse to external funds, which makes opportunistic insiders le
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