The financing of uncertain future investments
Studies in Economics and Finance
ISSN: 1086-7376
Article publication date: 24 January 2022
Issue publication date: 26 September 2022
Abstract
Purpose
The purpose of this study is to investigate the effects of two important financing sources, debt and cash, on a firm’s investment decisions and explores the intertemporal impact of this financing on future investment volatility.
Design/methodology/approach
This paper first reports our results using ordinary least squares (OLS) estimation and then employ an instrumental variable (IV) strategy which addresses potential endogeneity that arises from future investment volatility on current capital structure and cash levels.
Findings
This paper finds firms with low levels of debt or high levels of cash experience higher future investment volatility, and the probability of large future investment increases with high cash levels. This study’s findings are economically important; for example, a one-standard-deviation increase from the mean of debt ratio implies an approximate 7.8% decrease in future investment volatility; and a one-standard-deviation increase from the mean of a firm’s cash level leads to a 47% increase in the probability of a large investment in the next year.
Originality/value
The findings of this study help firms understand the impact of their present financing decisions on the plausibility of their future investments. This paper contributes to the literature by making both novel and confirmatory findings. This paper was structured to include confirmatory findings for two reasons. First, this paper uses different methods to construct investment volatility and the related investment spike. Second, and more importantly, the hypotheses are interrelated and communicate how firms plan for and execute against uncertain future investments. Growth options are ephemeral, and the hypotheses structure provides a guideline for how a firm finances future growth options.
Keywords
Acknowledgements
The authors thank participants at the Victoria University of Wellington Brown Bag seminar, Massey University seminar series, University of Canterbury seminar series, the 2016 European Financial Management Association Conference, the 2017 Financial Markets and Corporate Governance Conference, and the 2018 New Zealand Finance Colloquium. All remaining errors are our own.
Citation
Yaghoubi, M. and Keefe, M.O. (2022), "The financing of uncertain future investments", Studies in Economics and Finance, Vol. 39 No. 5, pp. 754-771. https://doi.org/10.1108/SEF-02-2021-0083
Publisher
:Emerald Publishing Limited
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