Financial Constraints and Corporate Investment Efficiency: The Moderating Role of Cash Holdings
Abstract
This study is designed to observe the effects of financial constraints on the efficiency of investment for the non-financial sector of Pakistan's corporate sector, and cash holdings as a moderating variable. The study employs a panel least squares regression model using the balanced data of 50 non-financial firms listed on the Pakistan Stock Exchange for the period 2015– 2024 to test the financial constraints and investment efficiency relationship within the study. This research approach is used because it allows for the analysis of relationships between variables while controlling for other factors, which are proxied by firm-level variables such as Tobin's Q, profitability, leverage, asset tangibility, and firm age. In the residual-based approach (Biddle, Hilary and Verdi 2009), investment inefficiency occurs when the amount invested falls short of the expected level. The size-age (SA) index introduced by Hadlock and Pierce (2010) is used to measure the financial constraints. The results show that the financial constraints have a negative and statistically significant impact on investment efficiency, which supports the pecking order theory and the financial constraints theory. The findings indicate that cash holdings show a positive and statistically significant moderating effect and thus mitigate the negative relationship between financial constraints and investment efficiency. Firms that have a lot of cash at their disposal are better able to afford the financing of profitable investment opportunities when external financing sources are available at a high interest rate or are not available. Tobin's Q is found to be a positive influence on investment efficiency, suggesting the importance of growth opportunities in investment decisions, and the impact of profitability is also positive. Together, the model accounts for an R2 of 0.461 of the investment efficiency variations, which is a medium level of explanatory power. The results highlight the significance of internal liquidity management in the emerging markets with less developed capital markets and high financing costs. The study builds on the previous literature by incorporating cash holdings as a moderating factor in the financial constraints–investment efficiency relationship, thereby building on the previous focus of direct relationships.