Investment, acquisitions, and financial constraints

In this dissertation we examine the determinants of investment at the firm level. We investigate the impact of cash flow on investment, ownership on investment, and finally the classification and correlation of qualitative measures of financial constraint status with quantitative accounting variables. In the first essay we use a unique, hand-collected dataset, and find a significant positive relation between a firm's U.S. advertising spending and its contemporaneous foreign cash flow. This relation holds even after controlling for factors that should be related to the optimal level of U.S. advertising and is stronger for subsets of firms that we expect to be relatively more financially constrained including younger firms, firms that pay low dividends, highly levered firms, firms with low credit ratings, and firms that do not hedge. Our evidence supports the important hypothesis that there is a causal and economically substantial link between a firm's cash flow and its investment decisions, even for intangible investments such as advertising. In the second essay we study a sample of 555 brands that experience an ownership change and find that new owners often sharply increase or decrease advertising spending on the acquired brand, with large cuts being particularly common. Increased private ownership of a brand is associated with a significant downward shift in advertising relative to other deals. Buyers tend to cut advertising in existing brands that closely overlap with purchased brands, but do not cut spending on non-overlapping brands. Combined buyer-seller announcement returns are positively related to some measures of post-acquisition downward shifts in advertising spending. Acquired brands do not on average experience significant losses in market share, even when advertising spending is revised downwards. Our evidence is consistent with the hypothesis that the identity and characteristics of an asset's owner are important determinants of investment policy for the asset. In the final essay we examine the annual reports of 400 randomly chosen companies between 1995-2004 to investigate both the existence and implications of financial constraints based on qualitative and quantitative measures. We extend the work of Kaplan and Zingales (1997) and use over 1900 firm-year observations to construct indicators of financial constraints based on the management discussion and analysis section of annual reports and quantitative measures constructed from accounting data on COMPUSTAT. We use these measures to investigate how stable financial constraint classifications are over time and how robust they are to sample size issues. Further, we are able to ascertain whether the correlations between qualitative and quantitative measures of financial constraints have changed over time and what is driving this change. Finally, we re-investigate the sensitivity of investment to cash flow using an updated and more heterogeneous sample. We find that (1) the distribution of financial constraint status has changed over time; (2) the correlation between quantitative factors and qualitative financial constraint classifications has changed; and (3) the relation between investment and cash flow has decreased over time and is a questionable measure of financial constraint status when cash flow and investment are positively correlated.