The sensitivity of investment to internal and external funds: New emerging market evidence

Using a large panel of firm-level data from eight emerging African countries, we show that firms’ fixed investment expenditures are more sensitive to external funds, particularly debt, relative to internal funds. We further show that the investment sensitivity to external funds is associated with over-investment rather than financial constraints. This nexus remains strong through the financial crisis and after addressing measurement errors. Our study shows that the investment behavior of emerging market firms is influenced by the availability of internal and external funds and that the latter, whose role has received limited attention, is playing an ever-increasing role.