Two essays on the use of cash flows and the corporate policies

Essay One: Where did all the dollars go? The effect of cash flows on capital and asset structure This paper documents the short and long term balance sheet effect of cash flows. We show that cash savings in the short run and debt reduction in both the short and the long run account for a substantial fraction of cash flow use. Although, in the long run, investment exhibits substantial sensitivity to cash flows, investment does not absorb the entire cash flow shock. In fact, the tighter the financial constraints, the smaller the fraction of cash flow absorbed by investment and the more by leverage reduction. Firms stage their response to increases in cash flow, delaying investment while building up cash stocks and reducing leverage. These results suggest that much of the short-run economic effect of cash flow shocks to the corporate sector may be channeled into the corporate debt market rather than the capital goods market especially when financing constraints tighten. Essay Two: Investor Power, Creditor Power, and Cash Flow Use: International Evidence This paper investigates how firms in countries with varying levels of legal protection differ in the use of cash flow, and examines the implications for managerial agency problems. We find that firms in countries where shareholders are not well protected rely heavily on debt financing. When they have additional cash flow, they spend a substantial fraction to repay debt and therefore accumulate little in cash balance. These results show that debt restricts managers in countries where shareholders are not able to do so. Moreover the monitoring role of debt leads to a non-monotonic pattern of cash flow use for capital expenditure and dividend payout. Firms in the strongest and weakest shareholder protection countries spend less on capital expenditure and pay out less as dividends compared to those in the medium group. Finally, we also find that debt introduces conflicts. The creditor power intensifies the conflicts and affects the use of cash flow differently depending on whether shareholders have effective control of managers. In countries where shareholder protection is poor strong creditors are associated with more debt reduction of out of cash flow; while in countries where shareholder protection is good firms pay out more as dividends and invest more out of cash flow when creditors are well protected