Financial deregulation of public capital markets that improves access to external financing could remove binding financial constraints, moderate cash and investment dependence on asset tangibility, and promote robust growth. Love (2003) finds that financial development has a positive impact on investment in firms, and Harford and Uysal (2014) show that access to debt markets influences firms' investment decisions. In this article, I ask whether and how differential access to capital markets affects cash and investment dependence on asset tangibility.
If improved access to capital markets removes binding financial constraints on firms, I expect that the sensitivity of money and investment to asset tangibility will be reduced by SEC financial deregulation. The change in the public float requirement has led to greater and improved access to equity financing for small listed companies. Consistent with the view that financing affects firms' financial policies, I find that improved access to public capital markets reduces the sensitivity of cash to asset tangibility.
I examine whether the deregulation of equity issuance, which gave small firms greater access to equity financing, affected the sensitivity of the subject firms to investment cash flow relative to the control firms. While deregulation of equity issuance has improved access to external financing, which can be valuable given the scale of corporate investment, this does not automatically translate into good investment decisions. Second, to the best of my knowledge, no previous study has investigated the effect of improved access to equity capital on the sensitivity of cash and investment to asset tangibility before and after an exogenous and significant shock to external financing.
I provide evidence that even in a developed market such as the US, greater access to equity financing is important for corporate monetary and investment policy.
3 Sample construction
Since smaller companies have fewer financing options compared to their larger counterparts, the removal of public disclosure restrictions for listing should facilitate their efforts to raise capital in the public stock markets. As a result, Gustafson and Iliev (2017) find that after deregulation; the companies in question have significantly increased their public equity issuance through shelf registration, and importantly, issuance costs for standard accelerated SEOs have decreased significantly. Iliev (2017) and account for the effect of the financial crisis by excluding firm-year observations for which more than six months fall within the financial crisis, as defined by the National Bureau of Economic Research.5 The final sample consists of 7213 firm-year observations. .
All data filters described earlier, such as the exclusion of firms with negative or missing assets and cash, excluding financial crisis period, and all continuous variables obtained at the 1% and 99% in both tails, are applied to the descriptive statistics. As can be seen in Table 2, the treated firms are smaller in terms of public float and size relative to the control firms, but they are very comparable in terms of other firm characteristics. This suggests that the untreated firms serve as a suitable control group to examine the effect of the deregulation of equity issuance on the reliance on cash and investment on asset tangibility.
4 Empirical strategy
Treated(0/1)i,t is a dummy variable set to one for companies with a public float of less than $75 million, zero otherwise. Because the effect of an individual Post(0/1)t term is added to the year fixed effects (δt), I exclude it from the specification. Because companies with high levels of tangibility have greater access to debt financing because they can pledge their assets as collateral, they have less incentive to hold cash. Therefore, it is expected that asset tangibility should have a negative marginal effect on cash.
By reducing the effect of asset tangibility on cash, deregulation should encourage investment by businesses with low tangibility. To examine the impact of the financial deregulation on investment sensitivity to cash flows, I follow Andren and Jankensgard (2015) and estimate the following model. Xi,t represents firm-level controls for Market-to-book, which proxies for investment opportunities, cash, and book leverage.
Coefficient β1 is the sensitivity of investment to cash flow, and coefficient β2 captures the impact of financial deregulation on the sensitivity of investment to cash flow. To examine the effect of financial deregulation on investment efficiency, I also estimate the following model. Investment efficiency exists when the residuals from the investment model are equal to zero, indicating that there is no deviation from the expected level of investment.
Positive deviations from the expected level of investment mean that firms are overinvesting, while negative deviations or residuals mean that firms are not undertaking all projects with a positive net present value. To examine how financial deregulation affected firm investment performance, I follow Biddle, Hilary, and Verdi (2009) and estimate a model that predicts firm investment levels based on growth opportunities using sales growth and alternatively Tobin's Q or both. Investmenti,t =α+β1Xi,t+εi,t, (4) where Investmenti,t is total investment and Xi,t is either sales growth or Tobin's Q.6 I estimate equation (4) cross-sectionally for each industry year based on Fama and French (1997) Industry Classification.
Again, a positive residual implies that a firm is investing at a higher rate than expected based on sales growth or Tobin's Q, representing overinvestment. However, a negative residual means that a firm's actual investment is less than the expected level, indicating a case of underinvestment.
5 Empirical analysis
- Financing, asset tangibility, and cash
- Information asymmetry, and tech intensiveness
- Financing and the investment-cash flow sensitivity
- Financing, asset tangibility, and investment
- Financing and the quality of investment decisions
- Financing and firm asset growth
The evidence to date suggests that deregulation has dampened the impact of asset tangibility on cash balances. First, I investigate whether deregulation is especially beneficial for companies with a high degree of information asymmetry. However, because deregulation of equity issuance leads to an exogenous increase in the availability of financing, I expect that firms with high information asymmetry will benefit more from deregulation.
To examine the differential impact of deregulation on the level of firm information asymmetry, I classify the sample of firms into low and high information asymmetry firms based on firm age. As mentioned earlier, I expect deregulation to be more important for firms with high information asymmetry. In this case, deregulation should have a greater impact on money sensitivity to asset tangibility for the high information asymmetry group than for the low information asymmetry group.
Again, I expect the deregulation to have a stronger impact on the sensitivity of cash to asset tangibility for with high technology intensity. All other things being equal, the treated firms that gained improved access to public capital markets after the deregulation should increase the use of external financing and increase the rate of investment. Specifically, the deregulation of equity issuance should lower the investment-cash flow sensitivity for treated firms relative to the control firms.
In column 2, I formally test whether the sensitivity of investment cash flows is affected by improved access to external finance after deregulation. This result is consistent with the interpretation that the treated firms had financial constraints before deregulation but experienced a relaxation of constraints after deregulation. I explore this implication by examining the impact of deregulation on the tangibility sensitivity of investments.
In column 3, I examine the baseline estimate of equation (1) to assess the role of deregulation. Deregulation by improving access to external finance reduces the tangible sensitivity of cash assets and enables firms to make more investments. I investigate this by looking at the asset side of firms' balance sheets to shed light on the implications of deregulation for firm growth.
6 Conclusion
Hsu, Po-Hsuan, Xuan Tian and Yan Xu, 2014, Financial Development and Innovation: Cross-Country Evidence, Journal of Financial Economics. Khurana, Inder K., Xiumin Martin and Raynolde Pereira, 2006, Financial development and cash flow sensitivity, Journal of Financial and Quantitative Analysis41, 787–808. Lyandres, Evgeny and Berardino Palazzo, 2016, Cash, competition and innovation, Journal of Financial and Quantitative Analysis.
Post(0/1) One for periods after the change in public fleet demand in 2008, otherwise zero. The ratio of capital expenditure investments to total assets at the beginning of the period Ln(Public Float) The natural logarithm of the public float. The market-to-book ratio of total book assets (AT) minus book value of common equity (CEQ) plus total market value of equity (CSHO ×P RCCC) all divided by total book assets (AT).
Asset tangibility Ratio of net property, plant and equipment (PPENT) to total book assets (BV). R&D expenditure Ratio of research and development expenditure (XRD) to total book assets (AT). Book leverage ratio of total book debt (DLC+DLTT) to total book assets (AT) Dividend paying firms (0/1) Once a year a firm pays dividend and zero otherwise; set to zero.
This table reports placebo estimation results for the effect of deregulation on the sensitivity of cash to asset tangibility. In columns 1 and 2, Treated(0/1) is one for a firm with a public float of less than $40 million and $120 million respectively, zero otherwise. The dependent variable, Cash, is the ratio of cash and marketable securities (CHO) to beginning period total assets (BV).
The dependent variable, Cash, is the ratio of cash and marketable securities (CHE) to total assets in the initial period (AT). Treated (0/1) is one for a firm with a public turnover of less than $75 million. Asset tangibility is the ratio of net assets, plant and equipment (PPENT) to total book assets (AT). Firm age is the natural log of the number of years a firm has been listed in Compustat. This table reports the estimation results for the effect of equity issuance disorder on investment sensitivity to asset materiality.
The dependent variable, investment, is defined as the ratio of capital expenditures to total assets at the beginning of the period. Asset tangibility is the ratio of net property, plant and equipment (PPENT) to total book assets (AT).
