Information asymmetry and investment–cash flow sensitivity

Bryant University, Department of Finance, United States; University of Connecticut, Department of Finance, United States; Fairfield University, Department of Finance, United States
Journal of Banking & Finance 01/2008; DOI: 10.1016/j.jbankfin.2007.09.018
Source: RePEc

ABSTRACT Models of capital market imperfections predict that information asymmetry decreases firm investment and increases the sensitivity of investment expenditures to fluctuations in internal funds. Previous empirical tests of the link between investment and financing decisions have relied on indirect measures of financial constraint due to market frictions. In contrast, we use more direct measures derived from the market microstructure literature. Consistent with the theoretical predictions, our analysis shows that scaled investment expenditures are on average lower and the investment–cash flow sensitivity is greater when the probability of informed trading is high. Our results are robust to alternative measures of informed trading and liquidity, but they are not pervasive in our sample.

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    ABSTRACT: We develop an information risk measure (ECIN) based on the price discovery of large trades. As the price series of large trades and small trades are cointegrated, the price discovery of trades can be easily estimated via the vector error-correction model (VECM). Intuitively, we use the VECM to study how a temporary gap between the large trade price and the small trade price for the same stock is closed. If most of the gap is closed through adjustment in the small trade price with little movement in the large trade price, this indicates large trade price has been closer to the long-run equilibrium price and hence that the large trade price has a greater price discovery function for the stock in question. Since informed traders prefer to trade in large size, firms whose large trades have a larger price discovery are deemed to have larger information risk. An important feature of ECIN that is inherent to its construction is that higher ECIN also means lower illiquidity. This feature helps to disentangle the pricing impact of information risk from that of illiquidity - a major advantage over other information risk measures in the asset pricing tests of information risk. We show that ECIN is priced and its predictive power of stock returns is far more significant than those of book-to-market and momentum.
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    ABSTRACT: We use the fact that limit orders on the New York Stock Exchange are not state-dependent to examine the nature of information flows during trading hours. If public information events were an important factor in equity return dynamics then either limit orders would not be a material source of liquidity, or the picking-off of stale limit orders would be a prominent feature. We examine the efficacy of six measures of asymmetric information and explore the extent to which stale limit orders confound their ability to measure the importance of private information in return dynamics. We confirm French and Roll's (1986) conclusion that public information releases during trading hours do not have a significant effect on these dynamics.
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    ABSTRACT: This study provides novel evidence of the impact of corporate social responsibility (CSR) on investment sensitivity to cash flows. We posit that CSR affects investment–cash flow sensitivity (ICFS) through information asymmetry and agency costs, commonly viewed as the two channels through which investment responds to the availability of internal cash flows. We find that CSR performance leads to a decrease in ICFS. We further find that ICFS decreases (increases) when CSR strengths (concerns) increase. Finally, we find that the effect of CSR on ICFS is driven by the areas Community, Diversity, and Human Rights. In sum, the findings of this study stress the relevance of CSR — in particular, of CSR activities that extend beyond compliance behavior and reflect what is desired by society — in reducing market frictions and improving firms’ access to financial capital.
    Journal of Business Ethics 02/2013; · 0.96 Impact Factor


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