Journal of Business Ethics (2009) 87:2540 !

Springer 2008
DOI 10.1007/s10551-008-9798-9

Investment Decisions, Liquidity,
and Institutional Activism:
An International Study
Alfredo M. Bobillo
Juan A. Rodriguez Sanz
Fernando Tejerina Gaite






ABSTRACT. The activism of institutional investors
tends more and more toward the supervision and control
of the behavior of the managers of big companies. In this
article, we present a model based on the creation of an
activism index that lets us evaluate such activisms effect
on the sensitivity of the investment policies of a company
in the face of financial variables (such as cash flow and
either of the nature of the assets or of the organi-
zational mechanisms that are implied in investment
decisions. Maximizing the value of the company and
minimizing capital cost are the two pillars that sus-
tain traditional theory. Nevertheless, neoinstitutional
organizational theories, in particular Jensens theory
1
liquidity ratio) and market variables (ownership concen-

of organizational architecture, propose a greater
tration and value creation index). To test our assertions,
we analyze firm-level data for United Kingdom (U.K.),
Germany, France, Denmark, and Spain during the period
19952004. Our results point to a significant reduction in
the sensitivity of company investment decisions in the
face of these variables, especially relative to intangible
capital, as a result of the neutralizing effect of activism on
the high agency costs of free cash flow and on the
information asymmetries of the market.

KEY WORDS: institutional activism, firm performance,
financial constraints, investment-cash flow sensitivities,
corporate investment



Introduction

Traditional financial theory is a theory of valuation

complexity, from which arises a systematic and
evolutionary vision of investment choices. Such
theories are founded on the principle of organiza-
tional efficiency. These approaches also require the
consideration of institutional and cognitive con-
tracts,
2
weaknesses that suppose limited rationality
on the part of actors and conflicts of interest on the
part of the participants within the sphere
3
in which
these activities occur.
In this context, the financial and strategic theories
of investment decisions are brought together, based
fundamentally on two elements: The first of these is
limited rationality, particularly the limitations of
cognitive capacity, which, together with the state of
technology, can strengthen or weaken organizational
efficiency, restricting the capacity to produce and
use knowledge. It is also necessary to consider costs
4
and as such has a normative goal in investment. This

incurred in the acquisition of knowledge. The
approach does not take into account an explanation



Alfredo M. Bobillo is a Professor of International Business at
University of Valladolid (Spain). His research interests lie in
the area of international business and multinationals firms.
Juan A. Rodriguez Sanz is a Professor of Finance at University
of Valladolid (Spain). He is currently investigating about
corporate finance and valuation of firms.
Fernando Tejerina Gaite is a Professor of Finance at University
of Valladolid (Spain). His research interests include corporate
governance and valuation of firms.
second element is the search for organizational effi-
ciency, which may be included in investment deci-
sions as the basis for the creation of value or
may more complexly address not only the creation
of value but also the method of its distribution
(Charreaux and Desbrie`res, 1998).
This framework suggests a concurrence in which
normative financial theory and neoinstitutional
theory can converge for the benefit of greater clarity
about the explanatory variables that shape
firms investment decisions. For its part, the search
to optimize investments, with the objective of
26 M. al. and 26


maximizing the wealth of shareholders, supposes
viewing cash flow as the total of shareholders
investment opportunities, represented as a continu-
ous curve. The relationship between investment and
cash flow has had a turbulent history. The evaluation
of cash flow only comprises one part of the element
of investment decision-making as we present it here,
as it is the normative characteristic of valuation that
traditional theory addresses. With respect to this,
various works since 1980, like that of Fazzari et al.
(1988), demonstrate the greater effect of cash flow
on the investment decisions of those firms that are
more likely to face financial constraints, an effect
which is interpreted as information-driven market
imperfections. Similar surveys show the same results
(Bond and Van Reenen, 2002; Hubbard, 1998).
Some other works suggest that the significance of
cash flow stems from its role in alleviating credit
frictions (Carpenter and Guariglia, 2003). Thus,
controversy remains over the role and significance of
cash flow in investment decisions.
On the other hand, neoinstitutional theories
5

place emphasis on organizational mechanisms as
useful tools in making optimal investment decisions.
From this perspective, it is important to consider the
distortions induced by the imperfections of capital
markets that create information asymmetry, which
in turn translate into conflicts of interest between
shareholders and bondholders, current shareholders
and future shareholders, and, above all, managers and
shareholders. These distortions can create a policy of
underinvestment, as a result of communication
problems between the company and outside inves-
tors, or overinvestment, if the managers take part in
investment projects that maximize their utility over
the firms value. The central problem that links
information asymmetry to investment decisions is
that the exchange of information is costly. Conse-
quently, optimal investment decisions would seek to
minimize such costs and ensure that corresponding
benefits exceeded them. Therefore, in addition to
considering cash flow, it is necessary to take into
account other market or organizational variables,
like institutional activism, ownership concentration,
and, finally, the companys future performance.
The objective of this paper is to analyze the
influence of traditional variables, like cash flow, on
investment decisions, and to additionally incorporate
other variables derived from neoinstitutional theory
that can illuminate what happens within a firm and
in financial markets during the companys invest-
ment decision-making process. The rest of the paper
proceeds as follows: In Section Theoretical back-
ground and hypotheses, we discuss the alternative
analytical framework in more detail, outlining test-
able hypotheses. Section Data and methodology
describes the data and the empirical model of
investment. Section Results and discussion dis-
cusses the findings, and the last section presents the
conclusions.



Theoretical background and hypotheses

There is a consensus on the existence of information
asymmetries between firms and markets, and the
consequent agency problems motivate investments
in physical capital and intangible capital, mainly
R&D, to be initially financed with internal funds
(Fazzari et al., 1988; Jensen and Meckling, 1976;
Myers and Majluf, 1984; Stiglitz and Weiss, 1981).
However, the differences between investments in
tangible and intangible assets particularly the
greater risk, adjustment costs, and sunk costs of the
latter (Arrow, 1962) make it difficult to evaluate
the relationship between cash flow restrictions and
intangible investments.
In the group of studies analyzed here it is evident
that financial restrictions more basically, cash
flow have a significant impact on the investment
policies of a firm.
6
Most of the works considered
show how financial variables are often cited to
explain different behaviors, and only in some cases
are certain institutional characteristics of the financial
systems of various countries considered. Neverthe-
less, none of the arguments presented take into
account the different nature of certain assets or the
organizational mechanisms at play in investment
decisions. It eventually becomes necessary to address
other variables, like institutional activism, ownership
structure, and the potential growth of a company,
among others, that can contribute significantly to
our understanding of the investment decision-
making process.
The separation between ownership and control
leads to a kind of pathology that, in many cases,
requires a specific treatment. The different interests
of managers and funding providers create certain
27 M. al. and 27


attitudes and behaviors on the part of participants in
the company that have repercussions on the making
of financial and investment decisions. It seems evi-
dent that institutional investors display behavior that
is different to that of individual investors, and
they play a more active role in the supervision of
investment decisions. Although the activism
7
of such
participants does not resolve the principal-agent
problem inherent in corporate governance, it can
indeed alter the repercussions of that conflict on all
those involved.
Shleifer and Vishny (1989) were the first to point
out how specific investments may be chosen by
managers concerned about avoiding replacement,
thereby contributing to those managers entrench-
ment. Later, Charreaux (1997) showed how this
kind of strategy could generate inefficiency as a
result of the manipulation of information
8
for the
purpose of increasing the dependency of investors on
managerial decisions. A policy that pursues growth,
based on investments that encourage entrenchment,
can have negative effects for the shareholder, because
such a policy likely gives up investment in intangible
assets, like R&D, at a high cost in lost opportu-
nity. On the other hand, the making of idiosyn-
cratic investments may also not be an obstacle to
strengthening a managers reputation.
Given this, activism leads institutional investors
to distrust those managers that may make non-
redeployable
9
investments or who have opted for a
strategy of growth. This behavior also takes on
particular significance, depending on the ownership
concentration and on the economic sector to which
the company belongs. Accordingly, we propose the
following hypothesis:

H1: Higher levels of activism will condition the
sensitivity of investment policy in tangible
capital in relation to market variables (the
ownership concentration and the value crea-
tion index of the company) and in relation to a
companys belonging to a certain economic
sector.

On the other hand, investment in intangible assets
like R&D carries more risk and other particularities
than ordinary investments. Managers have better
information about the probability of success for their
R&D projects than do outside investors or lenders.
Likewise, the value of R&D is in the future output
of new products and processes, which outsiders
cannot depend on as a guarantee in the present. This
is because one cannot determine with precision the
value of such investments. Strategic considerations,
added to issues of risk and uncertainty, can be a
further source of information asymmetry between
suppliers and receivers of funds. In this context,
managers may be reluctant to let the content and
objectives of their technological activities filter
outward, given the possibility of their being appro-
priated by rivals.
Another essential characteristic of investments in
intangible assets, as contrasted with those in tangible
assets, is the existence of high fixed adjustment costs
entailed by investments in R&D, as a result of
indivisibility. Such costs are due to the high number
of qualified personnel that must be hired, a number
difficult to modify from one year to the next. This
makes it difficult to evaluate the possible impact of
current financial restrictions on decisions to invest in
intangibles, given the rigidity of short-term cost
changes in this sort of investment.
In these circumstances, supervision by institu-
tional investors may be stricter, as a result of the
uncertain results implied by these sorts of invest-
ments. At the same time, this supervision may help
maintain a better balance of power within the
company, because of the increase in resources with
uncertain results controlled by the managers of the
company.
Given all of the above, we put forward our
second hypothesis:

H2: In the context of the uncertainty and risk
carried by investments in intangible assets, the
level of activism may cause different behavior
of market variables (ownership concentration
and value creation index) in some countries
than in others, as a function of the develop-
ment of each countrys financial markets
and the relative level of legal protection of
investors.

Along these same lines of argument, we propose
examining the role that may be played in invest-
ment-cash flow sensitivity by greater or lesser levels
of activism on the part of institutional investors. The
impact of cash flow on firm investment decisions has
28 M. al. and 28


been analyzed in depth by Tinbergen (1939), Klein
(1951), and Meyer and Kuh (1957), who show that
liquidity is a significant variable. The work carried
out by Fazzari et al. (1988) represented an important
development in this field, because in this work they
evaluate the financial restrictions of various kinds of
companies, classified by their high or low rate of
dividend payment. The authors show that those
companies with a low rate of dividend payment
present greater sensitivity of investment to cash flow
than those with a high rate of dividend payment.
Kaplan and Zingales (1997) took issue with this
perspective, pointing out the unsuitability of classi-
fying companies as a function of their capacity to
finance themselves, and they amplify the classifica-
tion criteria. Their results contradict those of Fazzari
et al., showing less sensitivity in those companies
with financial restrictions that in those without such
restrictions. Other works, like those of Schiantarelli
(1995), Hubbard (1998), and Fazzari et al. (2000),
have aimed criticism at the work of Kaplan and
Zingales, pointing out the subjective nature of
the information used to categorize the firms, as well
as the limited size of the sample of companies
with financial restrictions. In the end, Kaplan and
Zingales (2000) offered a conciliatory theory. Cleary
(1999) introduced a new element into the formula-
tion, classifying companies according to an analysis of
how much the payment of dividends increases or
decreases. The results show that investment-cash
flow sensitivities are lower for financially constrained
firms. More recent contributions can be found in Alti
(2003) and Gomes (2001), whose work provided
mixed conclusions about the role played by financial
restrictions on the generation of high investment-
cash flow sensitivities. Employing a simulation
model, Moyen (2004) reconciled the results of
Fazzari et al. (1988) and Kaplan and Zingales (1997)
by using subsets with and without pre-existing
financial constraints. Almeida and Campello (2002)
found that companies with financial restrictions have
greater sensitivity to investment-cash flow than
those that have free access to financial markets.
Using an outline of real options, Boyle and Guthrie
(2003) showed that whenever firms do not face
binding liquidity constraints, they are willing to
invest in less favorable projects. This can be inter-
preted as evidence against the classical view of
investment volume being decreasing in constraints.
In summary, the literature confirms the existence
of positive investment-cash flow sensitivity, signaling
that information asymmetry or agency costs are the
main parameters in the determination of this sensi-
tivity.
A high level of free cash flow can induce man-
agers to pursue a strategy of unrestrained growth
(Grossman and Hart, 1982) and cause overinvest-
ment (Jensen, 1986). The origin of this agency
problem is that the managers not only receive high
remuneration from big firms for pursuing this kind
of strategy (Conyon and Murphy, 2000), but they
can also achieve important benefits like prestige and
a good reputation (Dyck and Zingales, 2004). In this
way, a high degree of corporate liquidity can
encourage managers to invest in projects with
returns below hurdle rate. Corporate monitoring by
large outside shareholders can resolve the conflict of
interests between managers and shareholders.
Therefore, the cost of free cash flow can be reduced
as a function of the level of activism of the outside
group. A high degree of shareholder activism can
moderate the behavior of the managers during a
decline in performance, in the absence of managerial
entrenchment (Franks et al., 2001). Because the
shareholders take on the relative cost of exercising
control and only receive benefits in proportion to
their participation (Demsetz, 1983; Grossman and
Hart, 1980), supervision will only be effective if the
group of shareholders is sufficiently large and
undertakes a high level of activism.
Accordingly, we present our next hypothesis:

H3: Investment-cash flow sensitivity will be less in
firms with a high degree of activism, as a result
of the reduction of the agency costs of free cash
flow.

By contrast, if internal funds generated by the
company are scarce, the managers may find them-
selves faced with a problem of underinvestment due
to information asymmetry (Myers and Majluf, 1984).
This occurs when a company has insufficient funds
to finance a project and has to resort to financial
lenders. Less informed financial markets demand a
risk premium that reflects average project quality.
This risk premium can be set at elevated levels for
certain projects, and hence the managers may
abandon some projects with positive NPV as a result
29 M. al. and 29


of information asymmetry. The positive relationship
between cash flow and corporate investment
induced by information asymmetry will decrease
with lower levels of holdings by insiders. The
problem of underinvestment described above can be
mitigated if a large enough block of company shares
is held by a financial institution (Kahn and Winton,
1998). In this respect, Shleifer and Vishny (1986)
establish that the higher the level of shareholder
participation in a company, the greater their incen-
tive to obtain information about it. In consequence,
ownership of large blocks of shares by a financial
institution can reduce information asymmetries
between the company and financial markets, as a
TABLE I
Distribution of companies by sector

Sectors %

1. Agriculture 0.93
2. Energy production, and water 6.73
3. Metal and non-metallic products 5.49
4. Construction 3.90
5. Food, beverage, and tobacco 4.47
6. Textiles 3.37
7. Wood 1.56
8. Paper and printing 3.71
9. Chemical products 5.09
10. Rubber 1.41
result of the experience and activism of these insti-
tutions and their active participation in capital
markets.
Thus, we put forward the following hypothesis:

H4: A negative relationship is expected between
11. Industrial and commercial
machinery
12. Electronic and electrical
equipment
13. Measuring and controlling
instruments
5.66

5.37

3.17
institutional blockholding and ownership
concentration and investment-cash flow sen-
14. Transport equipment 2.32
15. Other manufacturing industries 1.16
sitivity, as a result of the reduction of infor-
mation asymmetries.
16. Transportation and
communications
4.95
17. Wholesale trade 5.52
18. Retail trade 7.19

Data and methodology
19. Real State and financial
intermediation
3.31

Data

The sample used here is made up of individualized
figures for private corporations belonging to differ-
ent industries, drawn from the databases Compu-
stat and Amadeus for the years 19952004, from
Spain, France, Denmark, Germany, and the United
Kingdom. The distribution of corporations by sector
and country is shown in Tables I and II. The initial
sample is composed of a total of 3,535 observations
for each period considered. The statistical databases
of the official institutions of each country
10
were
consulted to obtain the series of national consumer
price indices for the period under consideration,
which made possible the conversion of the nominal
values of the variables found into their real values for
the year 1995. Table II shows that the countries that
contribute the most firms to the sample are the
U.K., France, and Germany, followed by Spain and
Denmark, which contribute similar numbers of
companies to each other.
20. Other business services 3.88
21. Computer and related activities 11.15
22. Other professional services 9.67
Total 100.00
(3,535 companies)



Variables

As to the division of the sample, we use as a selective
variable the activism index (AI), obtaining two
subsets on either side of the median: companies with
low and high activism indices. As indicated in the
theoretical section of this paper, this lets us compare
and contrast companies in clusters characterized by
varying degrees of shareholder activism, testing our
hypotheses about activisms effect on investment in
tangible and intangible assets. For the estimation of
this index it is necessary not only to quantify the
ownership concentrated in the hands of the main
shareholder (C
1
), but also to know what kind of
shareholder they are (bank, pension fund, family
30 M. al. and 30


TABLE II
Distribution of companies by country

Countries (Cd) %

1. Germany 22.77
2. Denmark 4.61
3. Spain 4.72
4. France 23.11
5. U.K. 44.84
Total 100
(3,535 companies)



manager, public administrator). We assume that the
ability to exercise control is made apparent when the
proportion of ownership by the main shareholder is
pension funds or investment funds. The value of the
AI would be estimated between 0 and 1. Once those
observations have been eliminated for which the
total number of variables necessary for the calcula-
tion of the two equations are not available, the
median AI calculated for our sample reaches values
of 0.54941 (equation for investment in tangible
assets) and 0.55221 (equation for investment in
intangible assets).
The empirical test is based on two equations that
will be analyzed in more detail later in this section
and whose main variables are described next.
The first of the dependent variables to be con-
sidered is investment in stock representing tangible
or physical assets (ITCS), defined as:

ITA
i;t
FAD
i;t
greater than or equal to 10%. Thus, once the mean
AI for a certain period has been calculated, that
ITCS
i;t


TCS
i;t#1
3
periods median value becomes the key to dividing
the sample with the intention of estimating the
equations in each subset relative to investment in
tangible or intangible assets. The activism index (AI)
is calculated through the following expression
11
:

AI I
0
0:1T # 1I
fC1 &10g
1

in which T is equal to 1 if the main shareholder is a
bank or multinational (low activism), T is equal to
1.5 if the main shareholder is a family or domestic
firm (moderate activism), or 2 (high activism) if the
shareholder is a public pension fund or an invest-
ment fund. I
fC1 &10g
is a dummy variable that takes
the value 1 if the ownership concentration (C
1
) is
greater than or equal to 10%. Also, I
0
takes the
where ITA
i,t
(INTA
i,t
) INTA
i,t)1
) is investment
in fixed tangible assets by company i during period t,
defined as the difference between the book value of
net fixed assets for the periods t and t ) 1. FAD
i,t
is the
depreciation of fixed assets for company i during
period t. TCS
i,t)1
is the stock representing physical or
tangible assets for company i in the instant t ) 1.
All values are expressed in USD and are deflated
to 1995, the sample starting point, using the con-
sumer price indices of each country under consid-
eration. To calculate stock in net fixed assets we
applied the method of perpetual inventory with an
annual depreciation rate of 8%
12
for each year after
the first for which historical data for the company is
available. Thus:
form:
TCS
i;t
1 # d TCS
i;t

1
ITA

FAD
1

!
0:4
"

# i;t i;t
4
I
0

0:2
C
1
I
fC1<10g
0:5
0:9
C
1
# 0:1

I
fC1&10g

2

where initial fixed assets is equal to the net value of
fixed tangible assets for the first of those years for
which data is available.
with I
fC1<10g
again being a dummy variable that

takes the value 1 if the ownership concentration (C
1
)
is lesser than 10%. This implies the development of a
linear interpolation such that I
0
takes the value 0
The second dependent variable relates to invest-
ment in stock of intangible assets (IICS):

IIA
i;t
IAD
i;t
when C
1
0%; 0.5 when C
1
10%; and 0.9
when C
1
100%.
IICS
i;t


ICS
i;t#1
5
The AI shows different control that is exercised
by banks and institutional investors like public
where IIA
i,t
(INIA
i,t
) INIA
i,t)1
) is investment
in fixed intangible assets by company i during period
31 M. al. and 31




t, defined as the difference between the book values
of net intangible assets for the instants t and t ) 1.
IAD
i,t
is the depreciation of intangible assets for
company i during period t. ICS
i,t)1
is the stock in
intangible assets for company i during period t ) 1.
The values of intangible assets are deflated as
above. To calculate the value of stock in intangible
assets, the perpetual inventory method was again
used, with an annual depreciation rate of 15%
13
for
each year following the first for which historical data
for the firm is available. Thus:

ICS
i;t
1 # d ICS
i;t#1
IIA
i;t
IAD
i;t
6

where initial stock in intangible assets is equal to the
net value of fixed intangible assets for the first year
for which data is available.
Next, we present the set of independent vari-
ables that make up each of the equations to be
calculated. For the first equation, concerning
investment in tangible assets, the degree of liquidity
is represented by cash flow over stock in physical
or tangible assets:
CFTCS
CFi;t
; with CF being cash
flow

TCSi;t#1
generated by company i during period t, calculated
as Earnings Before Interest & Taxes (EBIT) plus
depreciation during the period in question. TCS
i,t
is
stock in physical or tangible assets of company
i during period t. The ownership concentration (C
1
)
is measured as the percentage of holdings in the
hands of the main shareholder. The value creation
index is calculated as
Methodology

With the object of testing the hypotheses proposed
in the theoretical section, and using the variables
described above, two econometric models are
constructed (one for each equation). The central
objective is to determine whether the existence of
information asymmetry in capital markets affects
investment decisions (both in tangible and intangible
assets) by introducing financial constraints into the
different kinds of capital contribution. Following the
work of Fazzari et al. (1988), we propose that
investment in fixed tangible assets by businesses with
credit rationing is particularly sensitive to the avail-
ability of internal resources, and so cash flow over
stock in physical capital will be one of the main
independent variables. Likewise, the variable VCI,
based on Marriss Q ratio (Value Creation Index)
which expresses the relationship between the market
value and the book value of equity capital, should
also be considered. Equity capital is the residual
balance between assets and debts. Given that the Q
ratio is a permanent indicator of the firms value for
the investors, expectations of future performance
could affect the investment policy of the firm.
Finally, the ownership concentration, in this case
measured as the percentage of shares held by the
main shareholder (C
1
), stands, as we have outlined in
the previous section, as one of the basic determinants
of investment decisions.
Along with the independent variables, and in each
of the equations, dummy variables representing each
IFP
i;t

M
i;t
=B
i;t

companys particular economic sector (Div) or
VCI
i;t

IPP
i;t

ROE
i;t
=k
i;t
7
particular country (Cd) were used. Nevertheless, the
high number of sectors included in the initial clas-
where IFP
i,t
(index of future performance) is defined
as the quotient of market value (M) and book value
(B) of equity capital. IPP
i,t
(index of past perfor-
mance) is the quotient of return on equity (ROE)
and the cost of capital (k). The second equation
applies these variables to investment in intangible
assets. Here the independent variables are the liquid-
ity ratio CANA (the quotient of current assets
and net total assets logged over one year), the own-
ership concentration (C
1
), and the value creation
index (VCI), already defined in the first equation.
sification (see Table I) makes a more simplified
division of sectors recommended. We therefore use
the Standard Industrial Classification Division
Structure (SIC), obtained from the COMPUSTAT
database, whose main clusters can be seen in
Table III. The variable Sc
j
, with j varying from 1 to
9, is thus a categorical variable that takes a value of 1
when the company falls in sector j and 0 if it does
not. Likewise, Cd
k
is a categorical variable with a
value of 1 when the company is from country k and
0 if not.
32 M. al. and 32


i;t 1
TCS
i;t 1

1k k;i
TCS
i;t 1




TABLE III
Distribution of companies by sector Standard
Industrial Classification Division Structure (SIC)

ITCS a b
CF
i;t

#

4


4
X


k1

b Cd
CF
i;t
#
Divisions

Division A: Agriculture, forestry, and fishing
Division B: Mining
Division C: Construction
Division D: Manufacturing
Division E: Transportation, communications, electric,
gas, and sanitary services
Division F: Wholesale trade
Division G: Retail trade
Division H: Finance, insurance, and real estate
Division I: Services
b
2
C
1i;t

X
b
2k
Cd
k;i
C
1i;t
k1
4
b
3
VCI
i;t

X
b
3k
Cd
k;i
VCI
i;t
g
i
e
i;t
k1

When the variable to be examined is the rate of
investment in intangible assets, as opposed to tan-
gible assets, the second equation is expressed as fol-
lows:

CA
i;t
IICS
i;t
d b
1

NA

i;t#1
b
2
C
1
b
3
VCI
i;t

Keeping in mind the variables chosen as repre-
sentative of investment, and the different indepen-
dent variables and dummy variables described above,
the first equation to be calculated is reflected in the
expression that we present next. Two more calcu-
lations are also made, one including dummy vari-
ables representing the industries to which the
companies belong, and another including the dum-
my variables representing the countries under
consideration.

CF
i;t

g
i
e
i;t
11

In this equation we can see the same group of
potential explanatory factors as in the first equation
with one exception: the liquidity ratio. In this case,
we expect investment in intangible assets to have
greater sensitivity to the degree of liquidity of the
firm.
14

The introduction of dummy variables represent-
ing sectors and countries into this second equation
follows the identical methodology for their intro-
duction into the first equation, and so we omit their
ITCS
i;t
a b
1

i;t#1
b
2
C
1
analysis here.
Important differences may exist in any of the
b
3
VCI
i;t
g
i
e
i;t
8



CF
i;t

models proposed as a function of shareholders
activism toward the control and governance of the
companys managers and information asymmetry
ITCS
i;t
a b
1

i;t#1
b
2
C
1

9

problems and, therefore, financial restrictions.
Bearing this in mind, the two models proposed are
b
3
VCI
i;t

X
c
j
Div
j;i
g
i
e
i;t
9
j2


CF
i;t

analyzed for two subsets of companies: those with an
AI below the sample median and those with an AI
above it.
In all the equations the subscript i represents the
ITCS
i;t
a b
1

i;t#1
b
2
C
1

5

company and t represents the time period. The
disturbance is broken down in each of the two
equations into two fundamental terms. The first of
b
3
VCI
i;t

X
c
k
Cd
k;i
g
i
e
i;t
10

these (

e
it

), comprises all those factors that have some
k2

Country dummies are also introduced in interac-
tive form in order to contrast the potential change
in the coefficients size for the rest of explanatory
variables:
kind of influence on the rate of investment. This
term constitutes a random disturbance and follows
the usual conditions for a classical linear regression
model. Nevertheless, fixed effect errors associated
with each company (g
i
) frequently exist within the
33 M. al. and 33


term, potentially correlated with the group of
independent variables, and these can introduce
important biases into the estimate. The existence of
this constant unobservable heterogeneity cannot
only be identified but also be adequately eliminated
by estimating the model in first differences. In
addition, the two-step estimator, which takes into
account the residual matrix from the first section,
offers robust estimates on autocorrelation and
heteroscedasticity (White, 1982).
In spite of all these measures, the endogeneity of
the independent variables considered can become a
serious problem in each of the proposed models.
In this case the panel methodology can present
important deficiencies that lead to inconsistent esti-
mations. Diverse techniques are available to resolve
this problem, among which we wish to highlight the
Generalized Method of Moments (GMM) (Arellano
and Bond, 1991; Mairesse and Hall, 1996) or the
asymptotic minimum mean-squared method (Cre-
pon et al., 1998). Nevertheless, the results obtained
through the use of these techniques turn out to be
fairly sensitive to the estimation method proposed
and resolving simultaneity or endogeneity can
introduce more problems than it solves (Griliches
and Mairesse, 1995). In the end, the GMM is a
frequently used method that not only corrects
problems of simultaneity and problems of observa-
tional error, but also gives a residual structure that is
robust in terms of autocorrelation and heterosced-
asticity, which makes it an appropriate technique to
apply to each of the models proposed.



Results and discussion

Table IV presents the summary statistics and the
results of our regression can be seen in Tables V, VI,
VII and VIII.
Columns 1 and 3 of Table V represent a simple
model showing how decisions to invest in tangible
assets are influenced by the financial variable of cash
flow (CFTCS) and market variables (C
1
and VCI).
The coefficients estimated from these variables are
significantly different from 0 at 1% level (positive for
CFTCS and VCI, and negative for C
1
), although
when the AI is greater than 0.5494 the coefficient
for each of these variables behaves differently. The
sensitivity of investment in tangible assets to CFTCS
grows with the level of activism, owing to the
greater idiosyncrasy and irreversibility of this type of
investment. This idiosyncrasy gives rise to a greater


TABLE IV
Descriptive statistics


Variables

Mean

Median

Standard Dev.

Minimum

Maximum

Total assets

2416.69

206.38

10270.63

6.14

162647.00
Issue market value 1846.49 179.29 7157.79 3.05 117664.93
Stockholders equity 782.89 89.20 2592.82 0.15 35963.00
Revenue 1914.29 253.78 6382.89 2.03 88963.00
ITCS 0.41 0.09 13.90 )12.13 766.70
IICS 2.92 0.02 37.98 )0.69 1129.62
AI 0.52 0.54 0.17 0.00 0.89
C
1 0.22 0.12 0.23 0.00 1.00
IFP 5.82 1.84 65.57 0.03 1863.13
IPP 5.43 3.84 21.44 0.00 975.63
VCI 1.95 0.52 24.23 0.00 785.70
CFTCS 22.36 0.25 1198.38 )0.06 66107.08
CANA
t ) 1 0.55 0.55 0.30 0.00 2.90
The variables in Table IV are defined as follow: ITCS Investment tangibl e capital stock; IICS Investment
intangible capital stock; AI Activism index; C
1
Ownership, IFP Index of future performance; IPP Index
of past performance; VCI Value creation index, CFTCS Cash flow over tangible capital stock;
CANA Current assets over Total net assets.
34 M. al.
TABLE V
and 34



Equation 1: investment in fixed tangible assets
Independent
variables
Activism
index < Median
Activism index > Median
(1) (2) (3) (4)

Dependent variable is investment in fixed tangible assets (ITCS)
CFTCS
C
1

0.011 (0.000)***
)0.029 (0.000)***
0.011 (0.000)***
)0.316 (0.000)***
0.090 (0.000)***
)0.024 (0.000)***
0.118 (0.000)***
)0.324 (0.000)***
VCI 0.105 (0.000)*** 0.0464 (0.000)*** 0.001 (0.000)*** 0.001 (0.002)***
Cons 0.064 (0.000)*** )0.186 (0.843) 0.131 (0.000)*** )2.890 (0.000)***
DivB 1.269 (0.646) 1.641 (0.064)
DivC

)0.458 (0.626)

2.810 (0.000)***
DivD 0.516 (0.597) 3.342 (0.000)***
DivE 0.429 (0.651) 3.284 (0.000)***
DivF )1.365 (0.248) 2.314 (0.000)***
DivG 0.030 (0.975) 2.683 (0.000)***
DivH 2.143 (0.090)* 2.396 (0.001)***
DivI 0.488 (0.595) 3.427 (0.000)***
Wald test 3.50e+09 (0.000)*** 2.44e+07 (0.000)*** 61417.11 (0.000)*** 4334.22 (0.000)***
Hansen test 132.48 (0.399) 76.11 (0.056)* 142.91 (0.190) 77.10 (0.443)
AR(1) )5.26 (0.000)*** )5.04 (0.000)*** )2.10 (0.036)** )2.09 (0.036)**
AR(2) )1.68 (0.092)* )1.97 (0.049)** )1.19 (0.234) )1.18 (0.237)
GMM estimation.
Coefficients estimated and P > |z| (between parentheses).
The Hansen test is distributed following a v
2
with as many degrees of freedom as coefficients estimated. The estimates in
the second and fourth columns include sectorial dummy variables.
*, **, ***Significant at 10%, 5%, and 1%.
Median 0.54941.
CFTCS Cash flow over tangible capital stock; C
1
Ownership; VCI Value creation index; Div Industry
dummy.

degree of managerial entrenchment, as the invest-
ments escape from shareholder control and fluctuate
more with the level of liquidity. This sensitivity,
nevertheless, remains at similar levels for C
1
, whereas
for the market variable VCI higher activism indices
dampen investment sensitivity. This verifies the
influence of the AI on the lessened sensitivity of a
companys investment in physical capital in relation
to market variables.
Columns 2 and 4 of this same table present a
model that takes into account the different industry
divisions as a dummy variable. In both models the
Wald test reflects a high level of joint significance,
although this turns out to be greater in the subset of
companies with a lower AI. Nevertheless, a higher
AI is apparent in industrial and service sector com-
panies, especially in divisions D, E, and I. It is in
precisely these types of economic sectors that
activism acquires its greatest importance, when one
takes into account the strong ties between the
industrial sector and the banking system in the form
of industrial investment and the important contri-
butions of the service sector to the output of the real
economy. In summary, it becomes apparent that the
introduction of economic sectors into the model
increases the sensitivity of investments in tangible
assets with respect to independent variables. The
negative value of the ownership concentration
coefficient demonstrates how large blocks of shares
being held in the hands of a few, as well as the nature
of the main shareholder, can reduce the ability of
external shareholders to act. In addition, one notes a
lesser impact of the companys value creation index
on decisions to invest in tangible capital when the AI
35 M. al.
TABLE V
and 35


VCI 0.455 (0.000)*** (0.413)
VCI 6.851 (0.347)

Hansen test 151.44 (0.452) 53.98 (0.475)
(0.000)*** (0.033)**
(0.053)* (0.203)

TABLE VI
Equation 1: Investment in fixed tangible assets
exclusively in Germany and Spain. This suggests, as
might be expected, that the economic and financial
environments of the countries considered in the
Independent
variables
Activism
index < Median
Activism
index > Median
analysis have little influence on a companys decision
to invest in physical capital, but rather that global-
ization has favored uniformity in investment deci-
Dependent variable is investment in fixed tangible assets (ITCS)
CFTCS 0.011 (0.000)*** 0.158 (0.000)***
C
1
)0.035 (0.000)*** )0.160 (0.225)
VCI 0.006 (0.000)*** 0.012 (0.421)
Cons 0.025 (0.000)*** 0.168 (0.000)***
CFTCS Cd1 2.790 (0.000)*** )1.282 (0.000)***
CFTCS Cd2 5.083 (0.899) )1.158 (0.233)
CFTCS Cd3 )0.191 (0.574) 0.170 (0.001)***
CFTCS Cd4 )6.676 (0.521)
C
1
Cd1 0.060 (0.016)** 0.152 (0.115)
C
1
Cd2 )0.964 (0.990) 0.846 (0.318)
C
1
Cd3 0.356 (0.000)*** 0.288 (0.007)
C
1
Cd4 )0.862 (0.748)
VCI Cd1 )0.044 (0.000)*** )0.012 (0.418)
VCI Cd2 )0.600 (0.868) )0.020 (0.919)


Wald test 43513.95 (0.000)*** 3302.86 (0.000)***




GMM estimate.
Interaction dummies by country.
Coefficients estimated and P > |z| (between parentheses).
2

sions of this nature.
Table VII displays the results of the models rela-
tive to investment in intangible assets. The coeffi-
cients of the financial and market variables increase
their influence significantly with respect to invest-
ments in physical capital, which, again, vary as a
function of the AI. Thus we see lower values for the
estimators when the AI is greater than 0.5994. In
reference to this, the results show the difficulty for
external shareholders to develop policies of super-
vision and control over managers in matters of
investment in intangibles, as a result of the uncer-
tainty and risk that such investments tend to carry.
The value creation index merits special mention
here, as it gains greater relevance and significance in
this type of investment for elevated activism indices,
making clear the neutralization of risk and uncer-
tainty that market valuation introduces into invest-
ment policies.
Table VIII includes the interaction dummy vari-
ables for countries in order to evaluate any changes
in decisions to invest in intangibles that may be
produced by different economic and institutional
The Hansen test is distributed following a v with as many
environments. The coefficients present significant
degrees of freedom as coefficients estimated. (1) Subset of
companies with an activism index below the median.
(2) Subset of companies with activism index above the
median.
*, **, ***Significant at 10%, 5%, and 1%.
Median 0.54941.
CFTCS Cash flow over tangible capital stock;
C
1
= Ownership; VCI Value creation index; Cd
(CFTCS, C
1
; VCI) Interaction country dummies.

is high, reflecting the lesser significance of the
market value of the company as it relates to its
investment policy. As hypothesis H1 suggests, the
model is constructed so as to capture the different
behavior of the variables for different levels of
shareholder activism.
Likewise, Table VI shows how in decisions to
invest in physical capital there are no differences
among countries for high levels of activism. Differ-
ences for reduced activism indices are concentrated
differences in the interactions of the CANA and C
1
variables with Cd2 and Cd5, and VCI with Cd5.
This finding is consistent with the proposal behind
hypothesis H2 and confirms what it predicts in the
sense that the greater or lesser degree of develop-
ment of financial markets and investor protection are
variables that shape institutional activism and influ-
ence decisions to invest in intangible assets. The
analysis also shows how the variable Cd5 (U.K.) is
significant in the majority of interactions, revealing
the particularities of the Anglo-Saxon market as far
as investor protection and the institutional envi-
ronment, as compared to the continental model
representative of the rest of the countries in the
sample.
A final consideration about the sensitivity of the
liquidity variable with respect to investment deci-
sions leads one to consider the strong influence of
the AI on all investment in intangible assets, where
36 M. al.
TABLE VII
and 36
influence on this type of investment of the differing TABLE VIII




Equation 2: investment in intangible assets
Independent
variables
Activism
index < Median
Activism index > Median
(1) (2) (3) (4)

Dependent variable is investment in intangible assets (IICS)
CANA
C
1

56.701 (0.000)***
)8.187 (0.000)***
102.240 (0.000)***
)4.796 (0.000)***
9.638 (0.000)***
)9.514 (0.000)***
10.827 (0.000)***
)2.583 (0.000)***
VCI 0.042 (0.233) 0.394 (0.005)*** 0.161 (0.000)*** 0.029 (0.000)***
Cons )26.29 (0.000)*** )18.05 (0.584) )0.735 (0.000)*** 0.724 (0.219)
DivA 5.302 (0.000)***
DivB 65.033 (0.677) )7.410 (0.000)***
DivC )103.6 (0.003)*** )18.54 (0.000)***
DivD )21.38 (0.512) )2.317 (0.000)***
DivE )46.71 (0.170) )10.68 (0.000)***
DivF )28.07 (0.428) )7.399 (0.000)***
DivG )14.39 (0.663) )4.884 (0.000)***
DivI )43.39 (0.189) )6.780 (0.000)***
Wald test 4124.94 (0.000)*** 1097.24 (0.000)*** 4.87e+07 (0.000)*** 1.20e+07 (0.000)***
Hansen test 89.19 (0.997) 69.38 (0.332) 100.63 (0.602) 95.44 (0.958)
AR(1) )1.31 (0.192) )1.4 (0.163) )1.07 (0.284) )1.07 (0.285)
AR(2) )0.38 (0.700) 0.24 (0.810) )0.17 (0.868) 0.25 (0.803)
GMM estimation.
Coefficients estimated and P > |z| (between parentheses).
The Hansen test is distributed following a v
2
with as many degrees of freedom as coefficients estimated. The estimations of
the second and fourth columns include sectorial dummies.
*, **, ***Significant at 10%, 5%, and 1%.
Median 0.55221.
CANA Current assets over Total net assets; C
1
Ownership; VCI Value creation index; Div Industry
dummy.

greater activism clearly brings about lesser
sensitivity to liquidity in relation to investment in
this type of asset. The results point to greater
effectiveness of supervision and control on the
part of external shareholders in intangible
investment decisions, as a result of the greater risk
and uncertainty that these investments produce,
whether these be caused by the agency costs of
free cash flow or by information asymmetries, as
hypotheses H3 and H4 predicted.



Conclusions

The results obtained identify the AI as a positive
discriminating factor that in some cases moderates
and in others intensifies the effects of contextual
variables like cash flow, ownership concentration,
and the value creation index of the company on
physical or intangible asset investment decisions.
As expected, the different natures of investments
in tangible and intangible assets, which are due to
the more idiosyncratic qualities of the former and
the greater risk and uncertainty that come with the
latter, cause the impact of the AI to produce dis-
tinct effects on each. Thus, in decisions to invest in
physical capital, the sensitivity of investments to
cash flow and the value creation index of the
company increases along with the AI. Likewise,
one can see how the results from the introduction
to the model of variables representing the various
countries under consideration do not change in
significance with the AI. This confirms that the
economic and financial environments have little
influence on this type of investment decision.
37 M. al.
TABLE VII
and 37
influence on this type of investment of the differing TABLE VIII




Equation 2: investment in intangible
assets

economic and institutional environments of each
country, in our case divided into two models: the
Independent
variables
Activism
index < Median
Activism
index > Median
Anglo-Saxon and the continental.
Finally, there is evidence of the moderating effect
of the AI on the sensitivity of investment policies to
Dependent variable is investment in intangible assets (IICS)
CANA 23.661 (0.000)*** 13.630 (0.000)***
C
1 )12.16 (0.000)*** )0.667 (0.000)***
VCI 14.525 (0.000)*** 0.048 (0.100)
Cons )25.24 (0.000)*** )3.757 (0.000)***
CANA Cd2 )702.2 (0.837) 27.765 (0.000)***
CANA Cd3 11.173 (0.128)
CANA Cd5 40.935 (0.000)*** )8.303 (0.000)***
C
1
Cd2
8531.3 (0.851) )56.59 (0.000)***
C
1
Cd3 )11.00 (0.012)**
C
1
Cd5 28.583 (0.000)*** 6.489 (0.000)***
VCI Cd2 )1027.4 (0.848) )0.656 (0.000)***
VCI Cd3 )0.661 (0.013)**
VCI Cd5 )17.68 (0.000)*** )0.181 (0.000)***
Wald test 4764.55 (0.000)*** 1.50e + 07 (0.000)***
Hansen test 77.74 (1.000) 105.78 (0.820)
AR(1) )1.33 (0.185) )1.08 (0.281)

cash flow. The oversight of institutional activism
attenuates investment-cash flow sensitivities, mainly
in intangible assets investment, either by reducing
the agency costs of free cash flow or by eliminating
information asymmetries.
We can conclude that the AI gains ever more
importance, either through its influence over the
behavior of managers in relation to free cash flow
and information asymmetry, or through its greater
impact on sensitivity to market variables with respect
to the investment policies of the company.



Notes
AR(2) )

GMM estimation.

0.28 (0.778)

)0.59 (0.553)
1
According to Jensen (1983), the choosing of
investments is not based exclusively on monetary flow,
and it is also important to consider the totality of actors
Interaction dummies by country.
Coefficients estimated and P > |z| (between parentheses).
The Hansen test is distributed following a v
2
with as many
degrees of freedom as coefficients estimated. (1) Subset of
companies with an activism index below the median. (2)
Subset of companies with activism index above the
median.
*, **, ***Significant at 1%, 5%, and 10%.
Median 0.55221.
CANA Current assets over Total net assets;
C
1
Ownership; VCI Value creation index; Cd
(CANA, C
1
; VCI) Interaction country dummies.




Nevertheless, one can see how, as our hypotheses
predicted, the AI has a moderating effect on the
influences of the financial variable CANA and the
market variables C
1
and VCI on decisions to invest
in intangible assets. Thus, we find lower values
from the estimators as the index of activism grows,
which is a consequence of supervisory behavior
undertaken by outside shareholders in this kind of
investment, owing to the greater risk and uncer-
tainty associated with the investments final out-
come. The results also confirm the significant
that participate in this decision.
2
In reference to this, traditional investment models
considered risk to be an exogenous variable, outside of
managerial control. Nevertheless, this principle cannot
be accepted if multiple risks exist and if managerial
involvement and control are emphasized.
3
Such changes in context reflect not only the legal
framework, but also the differing ownership structures,
and imply a whole new game plan for investment deci-
sions and their inseparability from financing decisions.
4
Jensen and Meckling (1992), basing their work on
that of Hayek (1945), postulate that the key to the per-
formance of an economic or organizational system lies
in its capacity to produce, acquire, and use the knowl-
edge necessary for decision-making.
5
In particular, the theory of organizational architec-
ture developed by Jensen (1983), as an extension of the
agency theory introduced by Jensen and Meckling
(1976).
6
A concise review of those studies that analyze the
relationship between financial restrictions and the invest-
ment decisions of a company requires a look at: Scherer
(1965), Mueller (1967), Elliot (1971), Grabowski (1968),
Branch (1974), Myers and Majluf (1984), Switzer (1984),
Devereux and Schiantarelli (1990), Hall (1992), Himmel-
berg and Petersen (1994), Carpenter (1995), Schiantarelli
(1996), Hubbard (1998), Harhoff (1998), Carpenter et al.
38 M. al. and 39


(1998), Mairesse et al. (1999), Bond et al. (1999), Hall et
al. (1999), and Mulkay et al. (2001).
7
Activism refers here to the involvement of insti-
tutional investors in the management of companies, as a
consequence of the conflict of interest between share-
holders and company managers.
8
According to Stigliz and Edlin (1992), any kind of
manipulation of information can contribute to manage-
rial entrenchment.
9
For Williamson (1994), non-redeployable invest-
ments refer to assets that can not be reallocated without
losing value, in case of the termination or signing of a
contract.
10
These official institutions were: the U.K.s ONS,
Frances INSEE, the German Federal Statistical Office,
Denmarks StatBank, and INE in Spain.
11
The choice of coefficients in Eqs. (1) and (2) have
been calculated to obtain a bounded index with a range
of values between 0 and 1.
12
This is the depreciation rate commonly used in the
literature. See the works of Cincera (2002), Mairesse
and Hall (1996), and Perez Garca et al. (2006).
13
This is the depreciation rate commonly used in the
literature. Please see the works of Cincera (2002),
Mairesse and Hall (1996), and Perez Garca et al. (2006).
14
See the works of Hall (1992) and Himmelberg and
Petersen (1994).



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Alfredo M. Bobillo and Fernando Tejerina Gaite
University of Valladolid,
Campus Miguel Delibes, 47011 Valladolid, Spain
E-mail: amartbob@eade.uva.es
E-mail: tejerina@sid.eup.uva.es

Juan A. Rodriguez Sanz
University of Valladolid,
Avda. Valle Esgueva, 47011 Valladolid, Spain
E-mail: jantonio@eco.uva.es
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