Managerial entrenchment, financial constraints, and investment choice in unlisted firms

• Published date: 01 January 2021
• Author: Dinithi Ranasinghe
• DOI: http://doi.org/10.1002/ijfe.1788
• Date: 01 January 2021

RESEARCH ARTICLE

Managerial entrenchment, financial constraints, and investment

choice in unlisted firms

Dinithi Ranasinghe

Department of Accountancy and Finance,

University of Otago, Dunedin, New Zealand

Correspondence

Dinithi Ranasinghe, Department of

Accountancy and Finance, University of

Otago, PO Box 56, unedin 9054, New

Zealand.

Email: dinithi.ranasinghe@otago.ac.nz

Abstract

This paper examines how internally generated cash is allocated for investment in

unlisted firms in the post-global financial crisis period. We estimate models using a

panel data set from unlisted firms in the United Kingdom from 2009 to 2014. With

the use of a commercially available credit rating and a widely used index in the

literature to proxy for external financial constraints, the paper concludes that less

financially constrained firms display a higher investment-cash flow sensitivity. This

association has been consistent across the post-global financial crisis period. We

find some evidence to suggest that investment inefficiencies reduce investment-

cash flow sensitivity, and this is intensified in the presence of external financial

constraints. We extend the investment choice literature in the presence of financial

constraints using evidence from unlisted firms. We also enhance the investment

choice literature by incorporating the managerial entrenchment effect along with

financial constraints. Provision of financial support for private entities is a crucial

policy focus for any government. We call for policymakers to enhance micro-

financing options for unlisted firms to reduce the impact from external financial

frictions.

KEYWORDS

financial constraints, investment inefficiency, investment-cash flow sensitivity, post GFC, unlisted

firms

1|INTRODUCTION

In the aftermath of the global financial crisis (GFC),

obtaining external financing from traditional capital markets

and commercial banks has been problematic for many

unlisted firms (Organisation for Economic Co-operation and

Development, 2015). These entities are often at the forefront

in job creation; they adopt new technologies rapidly and are

actively engaged in developing and adopting new business

models. However, the financial constraints faced by them

create an important challenge for policymakers pursuing sus-

tainable recovery and long-term growth. As internal cash is

a determinant of investment, it is important for policymakers

to understand how external financial constraints affect

internal cash flow use for investment in unlisted firms. In

this paper, we examine how financial constraints affect inter-

nal cash flow use in investment in the unlisted firms.

Intuitively, those entities that confront external financial

frictions are more likely to use internal cash flows for their

investment activities. However, the empirical evidence on

investment-cash flow sensitivity (ICFS) in the presence of

external financial constraints is not conclusive. With the use

of public firm evidence, one stream of the literature follow-

ing Fazzari, Hubbard and Petersen (1988) suggest that finan-

cially more constrained firms' investments are highly related

to their internal cash flows (Bond & Meghir, 1994; Carpen-

ter, Fazzari, & Petersen, 1998; Kashyap, Lamont, & Stein,

1994; Whited, 1992). Another stream of evidence following

Received: 2 January 2018 Revised: 11 December 2018 Accepted: 13 September 2019

DOI: 10.1002/ijfe.1788

Int J Fin Econ. 2019;1–13. wileyonlinelibrary.com/journal/ijfe © 2019 John Wiley & Sons, Ltd. 1

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