Corporate governance, accounting information environment and investment-cash flow sensitivity

• Published date: 01 October 2018
• Date: 01 October 2018
• DOI: https://doi.org/10.1108/IJAIM-04-2017-0049
• Pages: 492-507
• Author: Ming Li,Liang Song
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Corporate governance, accounting

information environment and

investment-cash f‌low sensitivity

Ming Li

Wuhan Technology and Business University, Wuhan,

China and Hubei Business Service D&R Center, Wuhan, China, and

Liang Song

Charlton College of Business, University of Massachusetts Dartmouth,

Dartmouth, Massachusetts, USA

Abstract

Purpose –The purpose of thispaper is to test the effects of antitakeover protection on investment-cashf‌low

sensitivity and whether these effects are moderated by f‌irms’accounting information environment and

agency problems.

Design/methodology/approach –To test theeffects of agency problems, the authorsuse the passage of

second-generation antitakeover laws as the testing ground, which is a pseudo-natural experiment that is

widely used in the accounting, f‌inance and economics literature (e.g. Armstrong et al.,2012;Bertrand and

Mullainathan,2003).

Findings –The authors’analysisshows that investment-cash f‌low sensitivityis greater when managers are

insulated fromtakeovers. The authors’results also demonstratethat the effects of the passage of antitakeover

laws on investment-cashf‌low sensitivity are greater when f‌irms’accountinginformation environment is poor,

which is measuredby fewer analysts following and higher analyst forecastdispersion. The authors also show

that the effectsof the passage of antitakeover laws on investment-cashf‌low sensitivity are greater when f‌irms

have severeagency problems, which are measured by more freecash f‌low.

Originality/value –The authors’researchextends the empirical accounting literatureabout the effects of

corporategovernance and accounting information environmenton f‌irms’operating and f‌inancial decisions.

Keywords Corporate governance, Investment, cash f‌low, Accounting information environment

Paper type Research paper

1. Introduction

Problems of f‌inancing constraintsresulting from f‌irms’agency and information asymmetry

problems when making investment decisions is a central point in academic research (Stein,

2003)[1]. However, the extant empirical accounting and f‌inance literature does not provide

convincing evidence on the effects of agency and information asymmetry problems on

f‌irms’investment-cash f‌low sensitivity (Cho, 1998;Goergen and Renneboog,2001;Hadlock,

1998;Vogt, 1994)[2]. In our paper, we test the effects of antitakeover protection on

investment-cash f‌low sensitivity and whether these effects are moderated by f‌irms’

JEL classif‌ication –M41, M48

This study was started as a chapter of Dr Liang Song’s dissertation at Rensselaer Polytechnic

Institute.This research acknowledgesthe support by Humanity and Social ScienceYouth foundation of

Ministry of Education of China (Project NO: 15YJC630060) and “Corporation Society Responsibility”

AcademicResearch Team of Wuhan Technology and BusinessUniversity (XSTD2016001).

IJAIM

26,4

492

Received18 April 2017

Revised28 July 2017

Accepted2 August 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 4, 2018

pp. 492-507

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-04-2017-0049

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

accounting information environment and agency problems. Specif‌ically, we use the

passage of second-generation antitakeover laws as our testing ground, which is a pseudo-

natural experiment that is widely used in the accounting, f‌inance and economics

literature (Armstrong et al., 2012;Bertrand and Mullainathan, 2003).

Theoretically, such antitakeover protection reduces management’s fear of a hostile

takeover, and managers are less concerned about subsequent job loss. Therefore, there will

be more agency problems (Bertrand and Mullainathan,1999, 2003). For example, Bertrand

and Mullainathan (1999) f‌ind evidence that managers increase managerial discretion to

affect wages. Bertrand and Mullainathan (2003) show that managers become more

entrenched and enjoy the quiet life. According to theories of capital-market imperfections,

the increased f‌inancing frictions caused by greater monitoring costs incurred by outside

investors will result in f‌irms being more dependenton internal cash f‌low to invest and have

greater investment-cashf‌low sensitivity (Hubbard, 1998).

However, the prior literature suggests that stronger takeover protection may be

benef‌icial to bondholders because it mitigates agency conf‌licts between shareholders and

bondholders by protecting bondholders from expropriation in takeovers (Klock et al., 2005;

Chava et al., 2008). In particular, Francis et al. (2010) f‌ind a negative association between

antitakeover protectionand the cost of debt. Therefore, antitakeover protection allowsf‌irms

to have better access to the debtmarket, and f‌irms are likely to rely more on external funds.

This perspective suggests that investment-cash f‌low sensitivity is lower for f‌irms that are

more protected from takeover threats. Therefore, the effects of the passage of antitakeover

laws on investment-cashf‌low sensitivity remains an empirical question.

We test the inf‌luences of the passage of antitakeover laws on investment-cash f‌low

sensitivity using a sample of manufacturing f‌irms between 1981 and 1994. Unlike the

Sarbanes–Oxley Act or RegulationFair Disclosure, the passage of antitakeover laws did not

occur in all states at the same time (Armstrong et al.,2012). The advantage of this empirical

setting is that it provides a control group of f‌irms in our empirical test, which allows us to

use a differences-in-differences approach to investigate the causal effects of corporate

governance on f‌irms’investment-cash f‌low sensitivities. Our investment equations are

similar to those of Fazzariet al. (1988).

We f‌ind robust evidence suggesting an increase in investment-cash f‌low sensitivity

when managers are insulated from takeovers. Our results also demonstrate that the effects

of the passage of antitakeover laws on investment-cash f‌low sensitivity are greater when

f‌irms’accounting information environment is poor, which is measured by fewer analysts

following and higher analyst forecast dispersion. We also show that the effects of the

passage of antitakeover laws on investment-cash f‌low sensitivity are greater when f‌irms

have severe agency problems,which are measured by more free cash f‌low.

Our paper contributes to the extant literaturefrom several perspectives. Specif‌ically, our

research extends the empirical accountingand f‌inance literature about the effects of laws on

f‌irms’operating and f‌inancialdecisions. For example, at the state level within theUSA, after

the passage of antitakeover laws, managers increase f‌inancial statement informativeness

(Armstrong et al., 2012); increase their pay performance sensitivity (Cheng and Indjejikian,

2009); mitigate earnings management(Zhao and Chen, 2009); increase managerial discretion

to affect wages (Bertrand and Mullainathan, 1999); reduce their use of debt (Garvey and

Hanka, 1999); enjoy the quiet life (Bertrand and Mullainathan, 2003); reduce dividend

payouts (Francis et al.,2011) and reduce their stockholdings (Cheng et al.,2005). Our paper

contributes to this stream of literature by showing that these laws also have a signif‌icant

impact on f‌irms’investmentbehaviors.

Accounting

information

environment

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