Explaining the Cash Flow Sensitivity of Investment in Australian Firms

Abstract

I investigate the primary determinants of the cash flow sensitivity of investment (CFSI) in Australian firms. My findings fail to support either of the two hypotheses which have previously dominated the literature — the asymmetric information hypothesis and the free cash flow hypothesis — indicating instead that there are multiple determining impacts culminating to create CFSI. I find that governance does not play a significant role in the determination of CFSI. I also offer an explanation for the earlier variations in findings across much of the existing literature, including financial distress driving the low CFSI of constrained firms; sales growth enhancing CFSI; high-asset firms reporting high CFSI; and financial constraint providing only a part of the explanation of CFSI. Ultimately, I find that CFSI is not a by-product of undesirable firm performance as previously thought, but in fact the outcome of an ability to utilise preferred internal financing for investments.