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
493
To continue reading
Request your trial