The investment-cash flow sensitivity and the financing constraints hypothesis for emerging markets: a bibliometric and systematic literature review

Following the seminal work of Fazzari et al. (1988) (hereafter FHP), investment-cash flow sensitivity is usually referred to as the “financing constraints” problem for a firm. The classical regression model of financing constraints, based on Fazzari et al. (1988), is expressed as follows:

where I is the investment or capital expenditures, K is the capital stock, typically measured using tangible assets at the beginning of the period, CF is the cash flow, and x is the firm-level confounding variables that may influence investment, and $ε$ is the error term. In Equation (1), i, and t superscripts denote firm-level (N) and time-level (T) observations, respectively. In this model, investment-cash flow sensitivity is expected to be positive and significant for financially constrained firms. However, the classification of firms as financially constrained is crucial and has been debated in existing literature (see Kaplan and Zingales, 1997), which challenges the criteria used by FHP. This challenge is especially relevant for emerging markets, where financial constraints are more complex to identify.

The main purpose of this literature review and bibliographic analysis is to provide a “how to do” guide for researchers interested in studying investment-cash flow sensitivity in emerging markets, rather than simply referencing seminal papers and drawing general conclusions as is typical in traditional literature reviews. By focusing on the specific characteristics of emerging markets, this paper aims to serve as a guide for future research in the field. Additionally, decision-makers and policymakers can use the insights on the investment-cash flow sensitivity, considering the unique characteristics found in emerging markets.

This paper is organized as follows. The systematic literature review is provided in Section 2. Section 3 presents the results of the bibliometric analysis. Section 4 provides the discussion and explores the research gaps identified from both the systematic review and the bibliometric analysis. Finally, Section 5 provides the conclusion.

This study first relies on a systematic literature review to analyze the financing constraints hypothesis in emerging markets. The research follows the methodology outlined by Kumar et al. (2020), Rosado-Serrano et al. (2018), and Billore and Anisimova (2021).

The search process utilized many databases, including Google Scholar, Emerald Insight, Science Direct, Taylor and Francis, Wiley, Oxford Journals, and Cambridge Core. A total of 941 papers on financing constraints were identified via Google Scholar. However, many of these papers were excluded as they focused on developed economies or addressed financing constraints from unrelated angles (e.g. R&D, exporting, or specific firm characteristics). Morgan Stanley Capital International (MSCI) classifications were used to determine which countries are considered emerging markets. Only papers published in journals indexed by the Web of Science (WoS) were considered, reducing the final number of papers related to emerging markets to 55 ^[1].

The inclusion criteria for this review included search queries such as “financing constraints and investment”, “financial constraints and investment”, and “investment cash flow sensitivity”. Papers from the Web of Science were used and only studies that provided sufficient details on their methodological approach and research design parameters were included (see Billore and Anisimova, 2021). To ensure comparability, studies based on a micro-level (or firm-level) datasets were selected, while those from the financial or manufacturing sectors were excluded. The period spans from 1990 to 2021, and the study follows the PRISMA guideline (see  Figure A1 in the Appendix).

This section uses Callahan’s (2014) 4W approach to structure the systematic literature review. Tables in this section are organized according to this approach.

Table 1 provides a summary of studies that examine the financing constraints hypothesis in emerging markets, listing relevant studies, the journal in which they were published, and the number of citations. The studies are heterogeneous in terms of the number of citations (see Table 1). The following section examines the countries that the studies focus on.

Table 1 shows the geographic distribution of studies in the existing literature, showing that most research on financing constraints in emerging countries is concentrated in India and China. These countries are the most active countries in research on this topic.

Table 2 shows the methodologies used in the current literature. Modeling the financing constraints hypothesis poses empirical challenges. Many firm-level analyses rely on financial statements, which can lead to simultaneity bias, where two-way causality may exist between investment and its determinants. Usually, lags of investment variables are often used as regressors to capture the inertia effect in econometric models. However, in addition to the simultaneity bias, the lagged investment variable may be correlated with the error term, a phenomenon referred to as “Nickell’s bias” (see Nickell, 1981), which contributes to the endogeneity problem in the econometric model. To address this, 27 of the 55 papers in the existing literature used the generalized method of moments (GMM) to address endogeneity and simultaneity biases.

As financial development and/or financial liberalization progress remains problematic, and the transition from a planned or closed economy to a free market economy is still problematic in emerging economies, investment-cash flow sensitivity and financing constraints play an important role. This sensitivity may be exacerbated by incomplete financial liberalization, which contributes to financial fragility in emerging markets.

The bibliometric analysis considered all 55 papers identified in the previous section, using VOSViewer 1.6.15 due to its convenience and compatibility with various file formats and databases. VOSViewer, developed by Van Eck et al. (2010), is widely used in bibliometric studies (see Molina-García et al., 2022; Donthu et al., 2021).

Figure 1, generated using VOSViewer, demonstrates that the main points highlighted in the existing literature are focused primarily on investment and financing constraints. Co-occurrence analysis generates thematic clusters, where the keywords of each document or paper reflect its content and appear in different papers (this is defined as occurrence). The frequency with which these keywords appear together with the authors' keywords (co-occurrence) helps identify the main themes and the process of knowledge accumulation in the literature (Alayo et al., 2020; Casado-Belmonte et al., 2021; Zong et al., 2013; Molina-García et al., 2022).

VOSviewer reported four thematic clusters characterized by the largest nodes, with terms such as “Financial Constraints,” “Financing Constraints,” “Investment,” “Investment Cash Flow Sensitivity,” and “Corporate Investment”, each appearing at least five times in the existing literature:

• (1)

  Cluster 1: Chinese enterprises, debt, financial liberalization, political connection, and Türkiye

• (2)

  Cluster 2: Banking system reform, China, state ownership,

• (3)

  Cluster 3: Financial crisis, financial development, financial reform, monetary policy

• (4)

  Cluster 4: Business groups, generalized method of moments, India

Figure 2 shows the most frequently cited papers in emerging market studies addressing the relationship between investment-cash flow sensitivity and financing constraints. However, aside from Hoshi et al. (1991), most of these studies focus on frameworks for developed countries. In this context, it is very difficult to compare the unique framework of emerging markets with those of developed countries.

Studies examining the financing constraints hypothesis in emerging markets often focus on the role of financial liberalization in alleviating such constraints (see  Table A1 in the Appendix). In these markets, firms frequently face higher external financing premiums compared to those in developed countries due to limited financial deepening. In theory, financial liberalization should help firms reduce their financing constraints by narrowing the gap between internal and external financing costs, a gap referred to as financial friction ^[2]. However, due to poor financial development, the banking sector plays a crucial role in providing external finance for firms in emerging markets. The role of banks as key players in the structural transformation of emerging markets has led to the rise of state capitalism, with the state-led banking system becoming increasingly dominant in these economies (Naughton and Tsai, 2015; Nölke et al., 2019; Petry et al., 2023).

In emerging markets, the challenge of overcoming financial frictions is compounded by banks' demands for additional collateral, as well as the difficulties in resolving information asymmetries. Several studies, starting with the seminal paper of Almeida and Campello (2007), have emphasized the role of collateral in addressing these issues. Moshirian et al. (2017) also highlighted this in the context of a comparative study of emerging markets. Therefore, firms operating in these markets should focus on increasing asset tangibility to improve their chances of accessing external finance. More research is needed to analyze financial markets (including the banking sector) within the framework of institutional structures concerning investment-cash flow sensitivity.

Emerging markets are vulnerable to external shocks and business cycles, leading to significant fragility. As Akyuz (2008) notes, such sharp fluctuations create uncertainty in these economies, which may prompt firms to forgo or cancel investment or capital expenditures (see Dixit and Pindyck, 1994; Keynes, 1936; Kalecki, 1937). During these periods of economic volatility, financially constrained firms struggle more to secure financing.  Table A2 (see Appendix) shows that business cycles or financial crises are key factors influencing investment-cash flow sensitivity for financially constrained firms in emerging markets.

The classification of financial constraints in emerging markets is a challenging task. As shown in Table 3, most studies rely on factors such as firm ownership, size, age, and business group membership to determine whether a firm faces financial constraints. The existing literature suggests that small firms, young firms, those affiliated with business groups, and those with state ownership tend to exhibit higher investment-cash flow sensitivity in emerging markets. The relationship between investment and cash flow under the financing constraints hypothesis is widely supported by studies focusing on emerging markets (see Table 3). However, classifications based on developed countries may not fully capture the realities of financial constraints in emerging economies, where weak investor protection and underdeveloped financial sectors are prevalent. Finally, firm-specific characteristics or dynamics that reduce investment-cash flow sensitivity should also be taken into account in the context of emerging markets ^[3].

Overall, the systematic literature review and bibliometric analysis suggest that there is no universal conclusion or understanding regarding investment-cash flow sensitivity in emerging markets in relation to financing constraints. Most studies frame this sensitivity within the context of financial liberalization (see  Table A2 and Figure 1) and financial crises, yet no consensus has been reached. Moreover, the firm dynamics featured in economic models play a significant role in determining the relationship between investment and cash flow sensitivity in emerging markets.

The issue of endogeneity often arises in these models, especially when lagged dependent variables are included as regressors on the right-hand side in the econometric model. Therefore, studies using standard OLS models may be biased. Nearly half of the studies reviewed fail to address this endogeneity issue. Re-estimating these models using the GMM method may yield different conclusions and shift the direction of the literature (see Table 3).

Another problem related to the selection of emerging market samples. First, data availability is often limited, as private companies (which are not listed companies) in emerging economies are rarely included, and the number of listed companies is small compared to developed economies. Second, accounting inconsistencies in emerging markets may limit the information available. For example, China did not have cash flow statements before 1988, and the adoption of International Financial Reporting Standards (IFRS) varies across countries, making comparison between emerging economies difficult. This lack of standardized financial statements forces researchers to rely on surrogate variables, which further restricts the availability of financial data. The adoption of IFRS could potentially improve the availability of financial reports for companies operating in emerging markets (see Ben Cheikh and Ben Rejeb, 2021; for a recent analysis supporting this claim).

Based on the literature review, the following research gaps can be identified:

• Research gap 1: To what extent does endogeneity influence investment and cash flow sensitivity in the existing literature, given that most studies use fixed effects or other instrumental regression methods?

• Research gap 2: To what extent do country-specific issues hinder the universal applicability of investment-cash flow sensitivity across all emerging markets? What commonalities exist among emerging markets in this regard?

• Research gap 3: How does cash flow facilitate investment through the mediating effects of the institutional context in emerging markets?

This paper presents a systematic literature review and bibliometric analysis of the financing constraints hypothesis in emerging markets. The existing literature proves the sensitivity of investment-cash flow for firms facing financing constraints in these markets, particularly where financial performance is weak, and capital markets are underdeveloped. It concludes that investment-cash flow sensitivity is an important phenomenon in emerging markets. Governments can offer incentives to financially constrained firms to improve their access to finance.

This study employs a systematic literature review and bibliometric analysis to highlight key aspects of the existing literature on investment-cash flow sensitivity and financing constraints in emerging markets. Financing constraints in these economies should be analyzed by focusing on financing frictions stemming from insufficient financial liberalization, state-led banking systems, firm characteristics, and unstable macroeconomic conditions (such as the business cycle). Additionally, the a priori classification of financial constraints remains a paradox for emerging markets, meriting further attention.

Moreover, policymakers should prioritize improving the efficiency of financial markets, particularly by addressing information asymmetries between parties that could be alleviated through regulation. Access to finance is an important driver of economic growth via the investment channel in emerging markets. Practitioners, especially C-suite executives, should recognize that investment-cash flow sensitivity arises from capital market inadequacies related to low levels of financial development in these markets. Therefore, they should consider strategies to secure financing premiums, especially when operating in firms with limited financial capacity. Designing approaches to access these premiums can help mitigate competitive disadvantages. C-suite executives and practitioners should also be mindful of the recurring business cycles typical of emerging markets.

Some parts of this study are derived from the Ph.D. thesis/dissertation titled “The Determinants of Investment in the Manufacturing Sector in Turkey”, which was submitted to Kadir Has University in 2017 and completed under the supervision of Professor Özgür Orhangazi.

The supplementary material for this article can be found online.