Investment Opportunities and Liquidity Constraints: Evidence from Two Emerging Markets, India and Pakistan

Abstract

This paper examines the relationship between the investment opportunities and liquidity constraints in the two South Asian emerging markets, i.e. India and Pakistan, over the period of 2010–2015. It reveals that there is a significant relationship between a firm investment opportunities and liquidity constraints. Using pooled OLS fixed effect model, we find a significant negative association between stock illiquidity (external liquidity constraint) and investment opportunities in both BSE and KSE firms. We also find a significant impact of firm’s cash flow to total assets ratio (internal liquidity) on firm’s investment opportunities. The results are statistically significant for both internal and external liquidity and investment opportunities in the presence of control variables like market-to-book ratio, size, leverage, and dividend payout ratio. Similarly, the results are robust for both emerging markets. The findings of this study are consistent with the findings of previous literature that liquidity is positively related to firm’s investment opportunities. Our study further clarify that both internal and external liquidity are important for firm’s investment opportunities.