Sensitivity of external resources to cash flow under financial constraints

• External financing to internally generated cash flow sensitivity is analysed.
• The role of tangibility on the former substitution effect is studied.
• The 2008–2010 period of special financial turmoil is assessed.
• The external financing is found to be negatively related to cash flow.
• The former negative effect is higher for listed (unconstrained) companies.

This paper explores the external financing–cash flow relationship in capital structure theory by comparing unlisted (financially constrained) and listed (financially unconstrained) companies. We postulate that investment is determined endogenously in the case of unlisted firms, as they are strongly dependent on internally generated funds (cash flow). Consequently, unlisted firms invest their cash flow in profitable projects, using any residual cash flow to increase their holdings of safe assets. In turn, listed companies determine their investment exogenously and may reduce leverage if they raise an excess of cash flow. As a result, listed companies would react more negatively to shocks in cash flow. Our findings reveal that both unlisted and listed companies show a negative external financing–cash flow relationship, that of the latter being clearly more intense.