Financial conditions, financial constraints and investment-cash flow sensitivity: evidence from Saudi Arabia
Journal of Economic and Administrative Sciences
ISSN: 1026-4116
Article publication date: 30 September 2020
Issue publication date: 22 October 2021
Abstract
Purpose
The purpose of this paper is to examine whether the sensitivity of investment to cash flow varies with exogenous financial conditions.
Design/methodology/approach
A dynamic model of investment based on the Euler equation approach is employed to investigate the impact of macro-financial factors on the sensitivity of investment to cash flow. The sample comprises data from 84 non-financial firms listed on Saudi stock market over the period 2007–2018.
Findings
The results show that the sensitivity of investment to cash flow is positive, implying the presence of financing constraints for Saudi firms. Evidence also reveals that better financial conditions relax firms' financing constraints. However, contractionary monetary policy, poor financial development and liquidity crisis strengthen the dependence of firms on internally generated funds when undertaking new investment projects.
Practical implications
The empirical results have useful policy implications. First, policymakers should pay attention to the importance of policymaking based on the monetary demand of microeconomic entities. In monetary contraction periods, firms face greater challenges in accessing external finance. These firms are likely to experience under-investment which at a macro level would translate into lower investments and economic growth for the country. Second, policymakers are encouraged to implement complementary measures that, coupled with existing financial reforms, may promote efficiency, competitiveness and transparency in firms' operations. Finally, managers and investors should consider financial structure and condition as important factors in their investment decision.
Originality/value
This study extends previous research by investigating whether the widely reported positive investment and cash flow relationship can be observed using data from an emerging market, specifically Saudi Arabia. It also sheds light on the investment-cash flow debate under a macroeconomic perspective and provides further evidence on the impact of financial crisis on the investment-cash flow (ICF) sensitivity.
Keywords
Citation
Guizani, M. and Ajmi, A.N. (2021), "Financial conditions, financial constraints and investment-cash flow sensitivity: evidence from Saudi Arabia", Journal of Economic and Administrative Sciences, Vol. 37 No. 4, pp. 763-784. https://doi.org/10.1108/JEAS-12-2019-0132
Publisher
:Emerald Publishing Limited
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