PENNIES AND PROSPERITY: UNRAVELING PAKISTAN'S INVESTMENT PUZZLE AMIDST FINANCIAL FLUX

Abstract

Financial constraints and agency cost problems have been identified as the potential cause of increasing investment- cash flow sensitivity (ICFS) of firms limiting the use of an external source of financing for investment opportunities and leading the firms to under-invest. This paper attempts to test this phenomenon in the context of Pakistani markets. Using the workhorse model of Richardson for the construction of free cash flow and abnormal investment, we used pooled OLS, Fixed effect, and GMM estimator on the dataset of 16 cement firms in Pakistan for the time frame of 2010-2022. The results indicate that cash, size, and Tobin’s Q are substantial indicators of a firm’s investment expenditure. Further, the results show that investment to cash flow sensitivity for over-investing (OI) firms with positive free cash flow (FCF) results from agency cost problems, whereas investment to cash flow sensitivity for under-investing (UI) firms with negative free cash flow (FCF) do not result from financial constraints. The study’s finding provides evidence of investment to cash flow sensitivity along with the presence of financial constraints and agency cost problems in Pakistani cement firms.