In this section, we examine how credit multiplier affects the external financing decision for both groups of firms

W estimate Eq. (3) to test for the possibility that credit multiplier exerts differential effect on both groups of firms. While estimating the impact of credit multiplier on firms’ external financing, we use external financing as the dependent variable and cash flow, growth, size, cash, inventory, PPE, debt/equity, tangibility (TANGIBILITY), and tangibility?cash flow (TANGIBILITY?CASH FLOW) as the independent variables. In order to ensure the validity of instruments used in the two-step system-GMM, we use the Arellano-Bond AR(2) test and Hansen J-test. Footnote 6 The estimated results of cash flow, growth, size, cash, inventory, PPE, and debt/equity on external financing are similar to the earlier findings reported in Table 5. Specifically, the results presented in Table 6 provide evidence that cash flow has a significant, negative effect on external financing for both types of firms. Furthermore, the external financing and cash flow relationship is more intense for financially unconstrained firms as compared to financially constrained firms.

The results reported in the table provide evidence that the coefficient of tangibility is negative and statistically significant, indicating that firms having more tangible assets do less external financing regardless whether firms are financially constrained or unconstrained. The pecking order theory of capital structure also suggests that the relationship between tangibility and external financing is negative. As tangible assets are easier to value for outsiders than intangible asset, they lower the information asymmetries between managers and financers. Low information asymmetries decrease the cost of issuing new equity. We also find that the best payday loans Oregon negative effect of tangibility on external financing is higher for financially constrained firms than financially unconstrained firms.

Turning to the estimates of the interaction between cash flows and tangibility, we find that the estimated coefficient of the interaction term is negative and significant for financially unconstrained firms in case of all three-classification criteria, whereas, for financially constrained firms, it is positive and significant for two out of three criteria. These results suggest that for financially unconstrained firms, the negative sensitively of external financing increases with asset tangibility. However, for financially constrained firms, the negative sensitivity of external financing to cash flow either decreases or turns positive as the tangibility of assets increases.

In this paper, we examine the external financing – cash flow relationship under financial frictions for a large panel of Pakistani non-financial firms to understand why more profitable firms need less external funds

This negative estimated coefficient of the interaction term for financially constrained firms suggests the higher flexibility to adjust the external financing when they have more tangible assets. This is apparently obvious, particularly when financially constrained firms have surplus funds they prefer to invest more in tangible assets to mitigate information asymmetries and increase external financing capacities. Moreover, they prefer to have surplus fixed assets, which they can easily sell off in periods when they require funds. In contrast, financially unconstrained firms boasting more tangibility do not react in a different way to such cash flow shocks as they are supposedly unconstrained and determine external financing exogenously.

Our findings are also in accordance with the macroeconomic literature. It is assumed that those firms are likely to get more external financing which hold more tangible assets, which will lead to new tangible asset and in future new external financing and so on (Bernanke et al. (1996) and Kiyotaki & Moore (1997)). Given this, it is assumed that firms those face difficulties in obtaining external funds try to accumulate more tangible assets and are more sensitive to credit multiplier effects.


We take the ratio of long-term debt plus shareholders’ equity to total assets as a proxy for external financing. We use three different classification methods to divide firm-year observations into financially constrained and unconstrained. We find a significant negative relationship between cash flow and external financing. We also find that the negative sensitivity of external financing to cash flow is higher for financially unconstrained firms as compared to their financially constrained counterparts.