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An Empirical Study: Financial-Market Imperfections and Investment

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  • Kim, ByungWoo
Abstract
Korean economy undergoes pre-modernized corporate governance. Financial-market imperfections assumed to be incorporated in equity ratio affect the sensitivity of internal funds to physical investment. Empirical analyses show that the effects of asymmetric information are significant. Theories predict that internal finance is less costly than borrowing or issuing equity. Higher cash flow from higher profits affects investment ratio. But, this marginal effect is decreased by equity ratio. If we assume that more imperfect financial market requires more equity than borrowing, we can see that agency costs change the way economic variables like cash flow affect physical investment. Cash flow plays two opposite roles for implementing investment. In the case of financial-imperfections, we can expect that firms with higher profits invest more. But, according to free cash flow hypothesis by Jensen (1986), managers with only a small ownership interest have an incentive for wasteful management. We can expect to see more wasteful activity in a firm with large cash flows. Our regression result shows that the former dominates the latter, so we get positive coefficient for cash flow variable on the physical investment.

Suggested Citation

  • Kim, ByungWoo, 2017. "An Empirical Study: Financial-Market Imperfections and Investment," MPRA Paper 82924, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:82924
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    References listed on IDEAS

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    More about this item

    Keywords

    Financial-market imperfections; Cash flow; Physical investment;
    All these keywords.

    JEL classification:

    • O50 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies - - - General

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