Sci.Int.

(Lahore),26(5),2591-2593,2014 ISSN 1013-5316; CODEN: SINTE 8 2591

IMPACT OF INTERNAL FINANCES ON CORPORATE

INVESTMENT IN PAKISTAN TEXTILE FIRMS
Abdul Haque1, Kashif Naeem, 1Rashid Waheed Qureshi
Department of Management Sciences, COMSATS Institute of Information Technology, Lahore Pakistan
1
ahaque@ciitlahore.edu.pk
ABSTRACT: Most of the researchers emphasized cash flow as an important determinant of corporate
investment. However trouble arises while interpreting its exact role in deriving corporate investment. The
present study mainly investigates cash flow role in determining corporate investment by using an
unbalanced panel data of 159 textile sector KSE firms from 1998-2011. Fixed effect model has been
applied to check the impact of cash flow and Tobin’s q on corporate investment. The empirical findings
illustrate that cash flow is significant and positive in determining corporate investment which implies that
managers are inclined to utilize internal finances for investment. Tobin’s q is also found to be a positive
predictor of corporate investment which suggests that on average textile firms undertake investment
whenever there is a growth opportunity.

Keywords: (corporate investment, cash flow, Tobin’s q, growth opportunity, Pakistan )

1. INTRODUCTION
The relationship between corporate investment and cash
flow has remained ambiguous among researchers for past
many years. The debate was initiated by [1], who
investigated cash flow and investment relationship on a
panel of US firms. They found that internally generated
funds or cash flows are preferred choice of financing for
investment in firms that have difficulty in obtaining funds
from outside sources. However, in [2] others opposed this as
given in [1] and argument that less financial constraint firms
have more sensitivity of cash flow towards corporate
investment. Other researchers like [3] and [4] however,
found a U-shaped relationship between the two variables.
Moreover, in [5] authors has found contrasting results while
analyzing a cross-country data. Therefore, it is evident that
the exact function of cash flow in determining corporate
investment is inconclusive among researchers. The present
paper is an attempt to investigate this role in context of
Pakistan and follows the approach of [1]. The study contains
a data of 159 textile companies listed on Karachi stock
exchange (KSE) during 1998 - 2011. Variables included in
the study are corporate investment, cash flow and Tobin’s q.
Panel data methodology has been applied to estimate the
results with fixed effect and random effect model.
Liquidity position of the firm is found to be a significant and
positive determinant of corporate investment, which
corroborates the existing studies. Tobin’s q is also found to
be a positive and significant variable in determining
corporate investment.
The remaining paper is structured according to following
pattern; Section II provides a concise review of existing
literature. Section III consists methodology adopt in the
paper. IV section describes results and discussion and
section V describes conclusion of the paper.
2 Literature Review
In study [1] author pointed out the role of cash flow in
determining corporate investment. They found that cash
flow is more sensitive for firms that are less financially
constrained. They posited that as different firms are treated
differently in financial markets, their dependence on cash
flow for investment purposes varies accordingly. However,
others in [2] found opposing results as compared to [1].
They argued that firms that are more financial constrained
have less dependence of cash flow for investment. Similarly
[6] also found the same result as [2] while working on a
larger dataset of 1317 US firms during 1988 – 1994.
In [7] authors of this study also analyzed the relationship
between cash flow and investment and found that it was
more pronounced in small and young firms which have high
growth opportunities. They argued that it was not
compulsory that only financial constraint firms show greater
cash flow – investment sensitivity, firms which have
frictionless access to credit also exhibit higher sensitivity of
cash flow and investment. [8] conducted a research in 36
countries to study the relationship of corporate investment
and its financial condition. They obtained data from
Worldscope database and included more than 7000 firms for
a time period of 1988 – 1998. VAR (vector auto regressive)
methodology was applied to analyze the impact of financial
component on investment. The result revealed that in
countries with less developed financial structure, firms
depicted high sensitivity to their fundamental component
(internal finances).
Authors in [3] and [4] also analyzed the relationship of
internal finances (i.e., cash flow) with corporate investment
while working on a US and UK data respectively. Their
results suggested that the sensitivity between investment and
cash flow is U-shaped with respect to internal financial
constraints and this sensitivity increased with the increase in
external financial constraint. Furthermore they found that the
firms that have more cash flows but are facing problems in
obtaining financing externally have higher sensitivity of
investment to cash flows.
Tobin’s Q relates investment of firm to its stock market
valuation and is a well known measure for investment
opportunities as argued by [9,10] and [11]. Others
[12].observed the relationship of Tobin’s q, firm’s size,
firm’s age and cash flow with corporate investment. They
included 720 UK firms in their study and found that cash
flow was positively influencing the investment. Tobin’s q
role was found to be mixed, with significant in full sample
2592 ISSN 1013-5316; CODEN: SINTE 8 Sci.Int.(Lahore),26(5),2591-2593,2014

but insignificant for smaller and younger firms. In [13] Table 1 describes the important descriptive statistics. The
authors also studied the role of Tobin’s q, cash flow and dependent variable of the study is corporate investment
firm size on 719 German firms over the period of 1961 – which is measured as the log of change in fixed tangible
1989. Firm level data was obtained from the annual reports assets, cash flow is measured as the sum of earning before
and German stock exchange. Tobin’s q and cash flow were extra ordinary items, depreciation and amortization, while
found to be positive and significant while size variable Tobin’s q is calculated as the ratio of market value of assets
proved to be insignificant. Elsewhere [14], it was also to book value of assets. The mean value of corporate
documented a positive and significant effect of Tobin’s q on investment is 17.80 with a standard deviation of 2.27. Cash
investment decision of a firm in Canadian firms. flow variable has 0.10 mean with deviation of 0.29 while
More recently [15] also supported the q model of investment Tobin’s q depicts 0.51 mean with 0.79 variations.
on the basis of their findings on a large sample of 1204
Chinese firms. They reported that Tobin’s q is significant Table-1
and positively linked to the corporate investment. In [16], Mean Median S.D Min Max Obs.
authors used accounting variables, Tobin’s q, firm size,
leverage and credit risk to determine the firm’s sensitivity of INVi,t 17.80 17.92 2.27 11.51 25.05 1355
investment from 2000 - 2005. Tobin Q proved insignificant CFi,t 0.10 0.07 0.21 -4.14 3.10 1774
during the study period while other variables like firm size, Qi,t 0.51 0.66 0.79 0.000 3.10 1903
leverage and credit risk were found to be negative and
significant. [17] proxy the growth opportunities of the firm IINi,t is the investment in fixed tangible assets, CFi,t is sum of
earning before extra ordinary items, depreciation and amortization,
by its Tobin’s q value while working on a sample of 678 UK Qi,t is the Tobin’s Q measured as MVA1 divided by BVA.
firms during the period 1996 – 2003. He found that
investment is positively and significantly attributed to
Tobin’s q value which implies that if growth opportunity 4.2 Estimations of Empirical regression model:
exists for a company then it is followed by subsequent Table 2 illustrates regression results2 which demonstrate that
investment to benefit from growth opportunity. corporate investment (INV) have a positive and significant
[18] studied the impact of different variables on corporate relationship with cash flow (b=0.90, p<0.01) and Tobin’s q
investment in Malaysian companies. The variables used in (b=0.53, p<0.05). Earlier researchers ([1, 2, 6, 7]etc) have
study were cash flow, Tobin’s q, debt ratio and bank loans. also found the same association of cash flow with
The multivariate regression analysis was used to analyze 300 investment. This positive relation supports that investment
firms from 2000 – 2007. The result depicted that the cash increases as cash flow of firm increases. [20] also argued
flow and growth opportunities (measured by Tobin’s q) have that investment of firms depends upon its liquidity position
a positive impact on investment. and this investment inclines when large funds are at firm’s
disposal. Positive result between cash flow and corporate
3 RESEARCH METHODOLOGY investment was also documented by other researchers
3.1 Data like[4,7,14,15,17].
The data is collected from listed firms of Karachi stock Tobin’s q (Q) is also positive and significant in determining
exchange (KSE). The sample is collected from 1998 – 2011. investment. Tobin’s q measure the growth opportunity of
Data comprises on 159 textile firms after dropping firms firms, the positive relationship signifies that when there is a
with fewer than three years data. The data is collected from positive growth opportunity for the firm it will undertake
companies’ financial reports. Panel data is used with fixed investment. The result is also consistent with previous
effect and random effect model. Hausman specification test studies like [1,14,15,17]. However, it is inconsistent with
[19] is later utilized for deciding a suitable method. The [21] and [16] who found insignificant effect of Tobin’s q in
following model is used in the study: determining investment.
3.2 Empirical Model Table 2
The following model is used in the study: INVit = β1 + β2 CFit + β3Qit-1 + εit
INVi ,t  1  2CFi ,t  3Qi ,t 1   i ,t Variables β Sig.
Where INVi,t is the investment in fixed tangible assets, CFi,t Const. 17.52 *** .000
(Cash flow) is sum of earning before extra ordinary items, CFit 0.901 *** .000
depreciation and amortization and Qi,t is Tobin’s Q which is Qit-1 0.530 ** .023
a proxy for growth opportunities. It is calculated as market
value1 of assets divided by its book.
Hausman Test 0.000
4 ESTIMATIONS Results of regression are obtained by Fixed Effect model.
4.1 Descriptives (Hausman specification test confirms the use of fixed effect
5.model). INVi,t (corporate
CONCLUSION ANDinvestment) is the dependent variable.
IMPLICATIONS
Independent variables are CFi,t (Cash flow), Qi,t is Tobin’s Q.
*10%significant level, **5% significant level, ***1% significant
1 2
where market value of assets is measured by book value of assets only Fixed effect results have level
been included after a significant
plus market value of equity minus book value of equity Hausman test value.
Sci.Int.(Lahore),26(5),2591-2593,2014 ISSN 1013-5316; CODEN: SINTE 8
The purpose of the paper was to investigate the role of cash
flow and Tobin’s q in determining corporate investment by
using an unbalanced panel data of 159 textile KSE firms
during 1998-2011. The study identifies cash flow as an
important determinant of corporate investment which
suggests that managers in Pakistan are relying heavily on
internal finances for investment purposes. Tobin’s q also
found to be a significant and positive predictor of corporate
investment in the sample which points out that investment
opportunities are followed by more investment. Further
study can be enhanced by including other sectors than
textile.
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