The source of investment cash flow sensitivity in manufacturing firms: is it asymmetric information or agency costs?

In the literature, positive investment cash flow sensitivity is attributed to either asymmetric information induced financing constraints or the agency costs of free cash flow. Using data from a sample of 68 manufacturing firms listed on the South African JSE, this paper contributes to the literature by investigating the source of investment cash flow sensitivity. We have found that asymmetric information explains the positive investment cash flow sensitivity better than agency costs. Furthermore, asymmetric information has been observed to be more pronounced in low-dividend-paying firms and small firms. Despite South Africa’s having a developed financial system by international standards, small firms are seen to be financially constrained. We attribute the absence of investment cash flow sensitivity due to agency costs to good corporate governance of South African listed firms. Thus the paper provides further evidence in support of the proposition in the literature that the source of investment cash flow sensitivity may depend on the institutional setting of a country, such as its corporate governance.