The role of managerial shareholding and financial constraints on investment decisions in Pakistan

Abstract

Imperfect capital markets are considered to have agency conflicts arising from asymmetric information between insiders and outsiders, affecting corporate investment decisions. This study investigates the role of managerial shareholding and financial constraints in investment choices of a firm. This research is conducted using panel data consisting of 60 non-financial firms listed on Pakistan Stock Exchange during 2011-2020. The two-step system GMM technique is applied in this study and the findings depict that managerial shareholding and financial constraints play a significant role in corporate investment decisions. Firms in Pakistan experience a positive incentive alignment effect of providing managerial ownership, which aids in overcoming agency problems and enhances the quality of investment projects undertaken by firms. Heavy dependence on internally generated funds for investments suggests the high “investment to cash flow sensitivity”, which signifies financial constraints. Results are in line with the hypothesis of agency theory, pecking order theory and Tobin’s Q theory. This study also explores the factors affecting investment decisions of manufacturing and energy-power sectors firms. The findings reveal that firms in the energy and power sectors are not financially constrained in terms of their investments, while the manufacturing sector firms exhibit a significant reliance on cash-flows which suggests higher investment cash-flows sensitivities. Furthermore, managerial shareholding exerts a negative effect on investment decisions of firms in energy and power sectors; however, no significant impact was found in the case of manufacturing firms. This study will be resourceful for shareholders, financial investors and policymakers who want to analyze factors affecting corporate investments.