Why do some authors view investment cash flow sensitivity as a symptom of underinvestment while others see it as symptoms of overinvestment?
Solution
Answer:
Investment cash flow sensitivity, some autohers consider asymmetric information theory which supposes that the information is not equally distributed between managers and suppliers of external finance, and other refer to agency theory.An assumption of asymmentric information theory is that managers act in the best intersts of existing sharehonders and extrenal investors can not assess the quality of investment project.Managers will prefer internal funds to finance new projects.This implies a positive relationship between the availabitility of cash flow and investment. Second in some cases managers will prefer to underinvest rather than to look for new investors. consquently investment cash flow senstivity can be a symptom of underinvestment.According to agency theory however manager a re assumed to take actions that are not in shareholders interest.To increase their power, manager undertake the highet level of investment.as a result, they may use a firm\'s free cash flows in unprofitable project.Investment cash flow sensitivity is then a symptom of overinvestment.
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Why do some authors view investment cash flow sensitivity as a symptom.docx
1. Why do some authors view investment cash flow sensitivity as a symptom of underinvestment
while others see it as symptoms of overinvestment?
Solution
Answer:
Investment cash flow sensitivity, some autohers consider asymmetric information theory which
supposes that the information is not equally distributed between managers and suppliers of
external finance, and other refer to agency theory.An assumption of asymmentric information
theory is that managers act in the best intersts of existing sharehonders and extrenal investors can
not assess the quality of investment project.Managers will prefer internal funds to finance new
projects.This implies a positive relationship between the availabitility of cash flow and
investment. Second in some cases managers will prefer to underinvest rather than to look for new
investors. consquently investment cash flow senstivity can be a symptom of
underinvestment.According to agency theory however manager a re assumed to take actions that
are not in shareholders interest.To increase their power, manager undertake the highet level of
investment.as a result, they may use a firm's free cash flows in unprofitable project.Investment
cash flow sensitivity is then a symptom of overinvestment.
