Efficiency in the face of uncertainty: is financial flexibility the answer? Evidence from emerging markets

Financial flexibility has become a significant aspect of corporate financial strategy that indicates the capacity of a firm to mobilise its resources to react to investment opportunities and shocks. In a macroeconomically uncertain environment characterised by institutional frictions, it is important to keep liquidity and idle borrowing capacity. Although widely important, there is limited evidence on the impact of different dimensions of financial flexibility on investment efficiency in emerging markets. The paper focuses on the issue of whether financial flexibility in terms of cash holdings and unused debt capacity enhances investment efficiency and whether global uncertainty moderates this association. We examine the role of internal and external flexibility in determining the capacity of firms to match capital expenditure and growth opportunities using firm-level panel data and a dynamic panel model. The results indicate that financial flexibility is a major boost to investment efficiency, and the impact of cash flexibility is more pronounced than the impact of debt capacity. Further, the positive influence of cash holdings is enhanced by global uncertainty, which is in line with the precautionary motive theory. Cross-sectional evidence suggests that the effects are stronger in highly leveraged firms, firms in a weak governance environment, and in high-uncertainty periods. On the whole, the findings indicate that financial flexibility, especially cash buffers, is a significant process of effective capital allocation in the face of uncertainty with significant implications for managers and policymakers.