The investment-cash flow sensitivity and the financing constraints hypothesis for emerging markets: a bibliometric and systematic literature review

Ömer Tuğsal Doruk

Journal of Business and Socio-economic Development

ISSN: 2635-1374

Open Access. Article publication date: 3 December 2024

223

Abstract

Purpose

The literature on financing constraints in emerging markets is still under-researched and is often described as a “black box.” This study aims to shed light on this underexplored area for emerging economies. Specifically, it attempts to understand the phenomenon of financing constraints through a systematic review and bibliometric analysis.

Design/methodology/approach

A systematic literature review and bibliometric analysis are used to identify the main features of investment-cash flow sensitivity and the financing constraints hypothesis in the context of emerging markets.

Findings

Financing constraints and investment-cash flow sensitivity in emerging markets should be analyzed in light of capital market imperfections, financial liberalization and macroeconomic conditions.

Research limitations/implications

This study is expected to serve as a valuable resource for researchers interested in the financing challenges faced by firms in emerging economies.

Originality/value

To the best of the author’s knowledge, this is the first comprehensive systematic and bibliometric literature review that examines the distinct characteristics of the financing constraints hypothesis on investment decisions in emerging markets.

Keywords

Citation

Doruk, Ö.T. (2024), "The investment-cash flow sensitivity and the financing constraints hypothesis for emerging markets: a bibliometric and systematic literature review", Journal of Business and Socio-economic Development, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JBSED-10-2023-0085

Publisher

:

Emerald Publishing Limited

Copyright © 2024, Ömer Tuğsal Doruk

License

Published in Journal of Business and Socio-economic Development. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode


1. Introduction

Following the seminal work of (hereafter FHP), investment-cash flow sensitivity is usually referred to as the “financing constraints” problem for a firm. The classical regression model of financing constraints, based on , is expressed as follows:

(1)Ii,t/Ki,t=α+CFi,t/Ki,t+βxi,t+εi,t
where I is the investment or capital expenditures, K is the capital stock, typically measured using tangible assets at the beginning of the period, CF is the cash flow, and x is the firm-level confounding variables that may influence investment, and ε is the error term. In , i, and t superscripts denote firm-level (N) and time-level (T) observations, respectively. In this model, investment-cash flow sensitivity is expected to be positive and significant for financially constrained firms. However, the classification of firms as financially constrained is crucial and has been debated in existing literature (see ), which challenges the criteria used by FHP. This challenge is especially relevant for emerging markets, where financial constraints are more complex to identify.

The main purpose of this literature review and bibliographic analysis is to provide a “how to do” guide for researchers interested in studying investment-cash flow sensitivity in emerging markets, rather than simply referencing seminal papers and drawing general conclusions as is typical in traditional literature reviews. By focusing on the specific characteristics of emerging markets, this paper aims to serve as a guide for future research in the field. Additionally, decision-makers and policymakers can use the insights on the investment-cash flow sensitivity, considering the unique characteristics found in emerging markets.

This paper is organized as follows. The systematic literature review is provided in . presents the results of the bibliometric analysis. provides the discussion and explores the research gaps identified from both the systematic review and the bibliometric analysis. Finally, provides the conclusion.

2. Systematic literature review

This study first relies on a systematic literature review to analyze the financing constraints hypothesis in emerging markets. The research follows the methodology outlined by , , and .

2.1 The search process

The search process utilized many databases, including Google Scholar, Emerald Insight, Science Direct, Taylor and Francis, Wiley, Oxford Journals, and Cambridge Core. A total of 941 papers on financing constraints were identified via Google Scholar. However, many of these papers were excluded as they focused on developed economies or addressed financing constraints from unrelated angles (e.g. R&D, exporting, or specific firm characteristics). Morgan Stanley Capital International (MSCI) classifications were used to determine which countries are considered emerging markets. Only papers published in journals indexed by the Web of Science (WoS) were considered, reducing the final number of papers related to emerging markets to 55 .

2.2 The inclusion criteria for the literature

The inclusion criteria for this review included search queries such as “financing constraints and investment”, “financial constraints and investment”, and “investment cash flow sensitivity”. Papers from the Web of Science were used and only studies that provided sufficient details on their methodological approach and research design parameters were included (see ). To ensure comparability, studies based on a micro-level (or firm-level) datasets were selected, while those from the financial or manufacturing sectors were excluded. The period spans from 1990 to 2021, and the study follows the PRISMA guideline (see ).

2.3 Review structure

This section uses 4W approach to structure the systematic literature review. Tables in this section are organized according to this approach.

2.3.1 What do we know about the financing constraints hypothesis in emerging markets?

provides a summary of studies that examine the financing constraints hypothesis in emerging markets, listing relevant studies, the journal in which they were published, and the number of citations. The studies are heterogeneous in terms of the number of citations (see ). The following section examines the countries that the studies focus on.

2.3.2 Where is the research happening?

shows the geographic distribution of studies in the existing literature, showing that most research on financing constraints in emerging countries is concentrated in India and China. These countries are the most active countries in research on this topic.

2.3.3 How was the research conducted?

shows the methodologies used in the current literature. Modeling the financing constraints hypothesis poses empirical challenges. Many firm-level analyses rely on financial statements, which can lead to simultaneity bias, where two-way causality may exist between investment and its determinants. Usually, lags of investment variables are often used as regressors to capture the inertia effect in econometric models. However, in addition to the simultaneity bias, the lagged investment variable may be correlated with the error term, a phenomenon referred to as “Nickell’s bias” (see ), which contributes to the endogeneity problem in the econometric model. To address this, 27 of the 55 papers in the existing literature used the generalized method of moments (GMM) to address endogeneity and simultaneity biases.

2.3.4 “Why should academicians, and policymakers know more about investment-cash flow sensitivity and financing constraints?”

As financial development and/or financial liberalization progress remains problematic, and the transition from a planned or closed economy to a free market economy is still problematic in emerging economies, investment-cash flow sensitivity and financing constraints play an important role. This sensitivity may be exacerbated by incomplete financial liberalization, which contributes to financial fragility in emerging markets.

3. Bibliometric analysis

The bibliometric analysis considered all 55 papers identified in the previous section, using VOSViewer 1.6.15 due to its convenience and compatibility with various file formats and databases. VOSViewer, developed by , is widely used in bibliometric studies (see ; ).

, generated using VOSViewer, demonstrates that the main points highlighted in the existing literature are focused primarily on investment and financing constraints. Co-occurrence analysis generates thematic clusters, where the keywords of each document or paper reflect its content and appear in different papers (this is defined as occurrence). The frequency with which these keywords appear together with the authors' keywords (co-occurrence) helps identify the main themes and the process of knowledge accumulation in the literature (; ; ; ).

VOSviewer reported four thematic clusters characterized by the largest nodes, with terms such as “Financial Constraints,” “Financing Constraints,” “Investment,” “Investment Cash Flow Sensitivity,” and “Corporate Investment”, each appearing at least five times in the existing literature:

  • (1)

    Cluster 1: Chinese enterprises, debt, financial liberalization, political connection, and Türkiye

  • (2)

    Cluster 2: Banking system reform, China, state ownership,

  • (3)

    Cluster 3: Financial crisis, financial development, financial reform, monetary policy

  • (4)

    Cluster 4: Business groups, generalized method of moments, India

shows the most frequently cited papers in emerging market studies addressing the relationship between investment-cash flow sensitivity and financing constraints. However, aside from , most of these studies focus on frameworks for developed countries. In this context, it is very difficult to compare the unique framework of emerging markets with those of developed countries.

4. Discussion

4.1 Theme 1: poor financial development, state-led banking and financial frictions

Studies examining the financing constraints hypothesis in emerging markets often focus on the role of financial liberalization in alleviating such constraints (see ). In these markets, firms frequently face higher external financing premiums compared to those in developed countries due to limited financial deepening. In theory, financial liberalization should help firms reduce their financing constraints by narrowing the gap between internal and external financing costs, a gap referred to as financial friction . However, due to poor financial development, the banking sector plays a crucial role in providing external finance for firms in emerging markets. The role of banks as key players in the structural transformation of emerging markets has led to the rise of state capitalism, with the state-led banking system becoming increasingly dominant in these economies (; ; ).

In emerging markets, the challenge of overcoming financial frictions is compounded by banks' demands for additional collateral, as well as the difficulties in resolving information asymmetries. Several studies, starting with the seminal paper of , have emphasized the role of collateral in addressing these issues. also highlighted this in the context of a comparative study of emerging markets. Therefore, firms operating in these markets should focus on increasing asset tangibility to improve their chances of accessing external finance. More research is needed to analyze financial markets (including the banking sector) within the framework of institutional structures concerning investment-cash flow sensitivity.

4.2 Theme 2: the open nature of emerging markets to business cycles

Emerging markets are vulnerable to external shocks and business cycles, leading to significant fragility. As notes, such sharp fluctuations create uncertainty in these economies, which may prompt firms to forgo or cancel investment or capital expenditures (see ; ; ). During these periods of economic volatility, financially constrained firms struggle more to secure financing. shows that business cycles or financial crises are key factors influencing investment-cash flow sensitivity for financially constrained firms in emerging markets.

4.3 Theme 3: financing constraints classification paradox and uncommon firm characteristics in emerging markets

The classification of financial constraints in emerging markets is a challenging task. As shown in , most studies rely on factors such as firm ownership, size, age, and business group membership to determine whether a firm faces financial constraints. The existing literature suggests that small firms, young firms, those affiliated with business groups, and those with state ownership tend to exhibit higher investment-cash flow sensitivity in emerging markets. The relationship between investment and cash flow under the financing constraints hypothesis is widely supported by studies focusing on emerging markets (see ). However, classifications based on developed countries may not fully capture the realities of financial constraints in emerging economies, where weak investor protection and underdeveloped financial sectors are prevalent. Finally, firm-specific characteristics or dynamics that reduce investment-cash flow sensitivity should also be taken into account in the context of emerging markets .

Overall, the systematic literature review and bibliometric analysis suggest that there is no universal conclusion or understanding regarding investment-cash flow sensitivity in emerging markets in relation to financing constraints. Most studies frame this sensitivity within the context of financial liberalization (see and ) and financial crises, yet no consensus has been reached. Moreover, the firm dynamics featured in economic models play a significant role in determining the relationship between investment and cash flow sensitivity in emerging markets.

The issue of endogeneity often arises in these models, especially when lagged dependent variables are included as regressors on the right-hand side in the econometric model. Therefore, studies using standard OLS models may be biased. Nearly half of the studies reviewed fail to address this endogeneity issue. Re-estimating these models using the GMM method may yield different conclusions and shift the direction of the literature (see ).

Another problem related to the selection of emerging market samples. First, data availability is often limited, as private companies (which are not listed companies) in emerging economies are rarely included, and the number of listed companies is small compared to developed economies. Second, accounting inconsistencies in emerging markets may limit the information available. For example, China did not have cash flow statements before 1988, and the adoption of International Financial Reporting Standards (IFRS) varies across countries, making comparison between emerging economies difficult. This lack of standardized financial statements forces researchers to rely on surrogate variables, which further restricts the availability of financial data. The adoption of IFRS could potentially improve the availability of financial reports for companies operating in emerging markets (see ; for a recent analysis supporting this claim).

Based on the literature review, the following research gaps can be identified:

  • Research gap 1: To what extent does endogeneity influence investment and cash flow sensitivity in the existing literature, given that most studies use fixed effects or other instrumental regression methods?

  • Research gap 2: To what extent do country-specific issues hinder the universal applicability of investment-cash flow sensitivity across all emerging markets? What commonalities exist among emerging markets in this regard?

  • Research gap 3: How does cash flow facilitate investment through the mediating effects of the institutional context in emerging markets?

5. Conclusion

This paper presents a systematic literature review and bibliometric analysis of the financing constraints hypothesis in emerging markets. The existing literature proves the sensitivity of investment-cash flow for firms facing financing constraints in these markets, particularly where financial performance is weak, and capital markets are underdeveloped. It concludes that investment-cash flow sensitivity is an important phenomenon in emerging markets. Governments can offer incentives to financially constrained firms to improve their access to finance.

This study employs a systematic literature review and bibliometric analysis to highlight key aspects of the existing literature on investment-cash flow sensitivity and financing constraints in emerging markets. Financing constraints in these economies should be analyzed by focusing on financing frictions stemming from insufficient financial liberalization, state-led banking systems, firm characteristics, and unstable macroeconomic conditions (such as the business cycle). Additionally, the a priori classification of financial constraints remains a paradox for emerging markets, meriting further attention.

Moreover, policymakers should prioritize improving the efficiency of financial markets, particularly by addressing information asymmetries between parties that could be alleviated through regulation. Access to finance is an important driver of economic growth via the investment channel in emerging markets. Practitioners, especially C-suite executives, should recognize that investment-cash flow sensitivity arises from capital market inadequacies related to low levels of financial development in these markets. Therefore, they should consider strategies to secure financing premiums, especially when operating in firms with limited financial capacity. Designing approaches to access these premiums can help mitigate competitive disadvantages. C-suite executives and practitioners should also be mindful of the recurring business cycles typical of emerging markets.

Figures

Co-occurrence analysis of author’s keywords in the existing literature

Figure 1

Co-occurrence analysis of author’s keywords in the existing literature

Studies commonly used by papers related to emerging markets, focusing on financing constraints and investment-cash flow sensitivity, with a minimum of 20 citations

Figure 2

Studies commonly used by papers related to emerging markets, focusing on financing constraints and investment-cash flow sensitivity, with a minimum of 20 citations

Studies included in the present study

No.The studyCountryCited byJournal
1China4China Finance Review International
2India125Journal of Developing Studies
3Iran2International Journal of Islamic and Middle Eastern Finance and Management
4South Korea51Small Business Economics
5China137Economics Letters
6South Korea, Malaysia, the Philippines, Thailand53Journal of Asian Economics
7China197Emerging Markets Review
8China50Chinese Economic Review
9India1Emerging Markets Review
10Turkey108Emerging Markets Review
11China5International Review of Economics and Finance
12ChinaN/AResearch in International Business and Finance
13South Korea20China Journal of Accounting Research
14India43Journal of Banking and Finance
15India, Indonesia, Malaysia, Pakistan, South Korea, Thailand9Financial Innovation
16India26Journal of Asian Economics
17India21Financial Innovation
18Viet Nam58Journal of Banking and Finance
19Mexico12Review of Finance
20Ecuador16The World Bank Review
21Sri Lanka252Journal of Developing Studies
22India304Canadian Journal of Economics
23Slovenia100Journal of Multinational Financial Management
24India28Economic Systems
25India105Journal of Developing Studies
26South Korea15Emerging Markets Trade and Finance
27China656Journal of Corporate Finance
28China60European Journal of Finance
29South Korea175European Financial Management
30China11Emerging Markets Trade and Finance
31Mexico, Turkey311Journal of Banking and Finance
32Turkey63World Development
33Brazil10Emerging Markets Trade and Finance
34India1Emerging Markets Trade and Finance
35Taiwan16Journal of Corporate Finance
36Taiwan58Corporate Governance: An International Review
37Brazil, Chile, Hong Kong, India, Indonesia, South Korea, Malaysia, Pakistan, the Philippines, Singapore, South Africa, Taiwan, Thailand, Turkey46Journal of Banking and Finance
38India119Emerging Markets Review
39Egypt, Ivory Coast, Kenya, Ghana, Morocco, Nigeria, South Africa, Tunisia, ZambiaN/AInternational Journal of Managerial Finance
40GhanaN/AInternational Journal of Managerial Finance
41Brazil13International Journal of Emerging Markets
42Saudi Arabia26International Journal of Managerial Finance
43ThailandN/AJournal of Economic and Administrative Sciences
44Saudi Arabia9International Journal of Managerial Finance
45Gulf Cooperation Council (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, UAE)N/AInternational Journal of Finance and Economics
46India2Review of Behavioral Finance
47Taiwan21Decision
48Bulgaria, Serbia& Montenegro, Czech Rep., Estonia, Croatia, Hungary, Latvia, Poland, Romania, Slovenia, Slovakia, UkraineN/AEurasian Business Review
49China16Comparative Economic Studies
50Taiwan29Pacific Economic Review
51China9Asia-Pacific Journal of Financial Studies
52Taiwan18Journal of Business Ethics
53Transition economies which are Bulgaria, Czech Republic, Romania, and Poland21Applied Financial Economics
54Bahrain, Kuwait, Oman, UAE, Saudi Arabia, Qatar26Economics Letters
55China6Emerging Markets Trade and Finance
352China Journal of Accounting Research

Note(s): N/A is used to the studies are published within last 1 year. For studies that utilize cross-country datasets, if at least one emerging market is included, the study is classified as an emerging market-related

Source(s): The author

The methodologies per study

The studyMethodology
OLS
OLS, GMM
OLS
OLS
OLS, IV, Panel FE
OLS
GMM
OLS
OLS, GMM
GMM
GMM
OLS
GMM
GMM
Panel Smooth Transition Regression Model
GMM
Stochastic Frontier Model, Pooled OLS, Panel FE
GMM
GMM
GMM
Matching, Heckman Selection
OLS, 2SLS
GMM, Panel Switching Regression Model
GMM, OLS
GMM
OLS
GMM
OLS
GMM
OLS, Mlogit
GMM
GMM
GMM
OLS
OLS
OLS, Higher Order GMM
OLS, 2SLS
GMM
GMM
GMM
GMM, GLS, OLS
GMM
GMM
OLS
OLS
GMM
OLS
OLS
OLS
OLS
OLS, IV, Heckman Selection Model, Matching Method
OLS
GMM
GMM
OLS

Note(s): OLS: Ordinary Least Squares, GMM: Generalized Method of Moments, IV: Instrumental Variables Estimations, 2SLS: Two Stages Least Squares; MLogit: Multinomial Logit, Panel FE: Panel Fixed Effects; Matching: Treatment models

Source(s): The author

Financial constraints classifications

The studyFC criterionIs investment-cash flow sensitivity supported under the financing constraints Hypothesis?a
N/AN/A
Business group affiliationYes
Debt maturityYes
Firm sizeYes
Politically connected firm statusYes
Family ownership statusYes
Firm sizeYes
State-owned status, Cash ratio, Firm size, Firm age, Liquidation ratio, Tangibility, Profitability, Product market competition, Firm-specific scoreYes
Firm sizeYes
Firm sizeYes
State-owned statusYes
N/AN/A
Firm size, Firm age, Business group affiliationYes
Ownership, Firm size, Debt capacity, Business group affiliationYes
N/AN/A
Dividend payment, Firm size, Business group affiliationYes
Firm Size, Business group affiliation, IndebtednessYes
State-owned status, Firm sizeYes
N/A
Firm size, Firm ageYes
Firm SizeYes
Firm Size, Business group affiliationYes
Firm SizeYes
Firm Size, Ownership, exporter statusYes
Firm Size, Ownership, debt levelYes
Business group affiliation, Firm size, debt levelYes
KZ Index, State ownershipYes
Politically connected firm status, Quality of corporate governance, Family firmsYes
Firm sizeYes
Ownership statusYes
Firm sizeYes, but there is no difference between small firms and large firms
Firm size, Financing constraints scoreYes
Ownership (Family firm status), KZ Index, WW IndexYes
Close banking relationships (especially with government banks)Yes
Family ownership status, Future growth opportunities (Low Q and High Q)Yes
Firm Ownership Status, Politically Oriented FirmsYes
Country and firm- level corporate governanceYes
Firm size, Business group affiliation, Firm’s ageYes
WW Index, KZ Index, Debt level, Firm size, HP Index, PP&E level, DividendsYes
N/A
Dividend paymentYes
Business group affiliationYes
Family ownership statusYes
Family ownership status, Sharia-compliant firmsYes
Sharia-compliant firmsYes
Dividend payment status, Coverage statusYes
Business group affiliation, Related party transactionsYes
Firm ownership statusYes
Regional disparityYes
Firm size, Index classification, Foreign investment ratioYes
Analyst coverage, DiversificationYes
Family ownership status, Future growth opportunities (Low Q and High Q)Yes
Irreversible investment statusYes
Working capital levelYes
N/AN/A

Note(s): aIf investment-cash flow sensitivity is found to be valid for at least one financing constraints classification, it is reported as “Yes”. WW: Whited-Wu Index, KZ: Kaplan and Zingales Index, HP: Hadlock-Pierce Index, PP&E: Property, Plant and Equipment, Q: Tobin’s Q

Source(s): The author

Notes

1.

This study focuses specifically on studies that directly address emerging markets. In this framework, studies that include mixed samples of emerging markets and developed economies in a cross-country framework are outside the scope of this literature review.

2.

At the same time, found a binding relationship between economic development and investment-cash flow sensitivity at the global level. Given that economic development often stimulates financial liberalization, this relationship is believed to align with the findings of this study, which emphasizes the connection between financial liberalization and investment-cash flow sensitivity.

3.

Recently, negative cash flow, cash flow volatility, and cash flow persistence have also emerged as important firm characteristics (see ; ; ). Although these studies focus on developed economies, these aspects should be further explored within the context of emerging markets.

Supplementary material

The supplementary material for this article can be found online.

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Further reading

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Acknowledgements

Some parts of this study are derived from the Ph.D. thesis/dissertation titled “The Determinants of Investment in the Manufacturing Sector in Turkey”, which was submitted to Kadir Has University in 2017 and completed under the supervision of Professor Özgür Orhangazi.

Corresponding author

Ömer Tuğsal Doruk can be contacted at: otdoruk@atu.edu.tr

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