The Effect of Financial Flexibility on Investment Efficiency: The Moderating Role of Conditional Conservatism and Agency Costs

Document Type : Original Article

Authors

1 Assistant Prof. of Accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Iran

2 M.A in Accounting, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

Abstract

Abstract Objective: Investment efficiency is a key indicator for evaluating a firm's ability to optimally allocate financial resources to profitable projects. Inefficient investment, whether underinvestment or overinvestment, can reduce firm value and increase financial risk. Financial flexibility, defined as a firm’s ability to maintain financing capacity, manage capital structure, and respond quickly to environmental changes without incurring substantial external financing costs, plays a critical role in enhancing investment efficiency. However, managerial and behavioral mechanisms, such as conditional conservatism in financial reporting and agency costs, may moderate or attenuate the effect of financial flexibility. This study aims to examine the impact of financial flexibility on investment efficiency and to assess the moderating roles of conditional conservatism and agency costs in this relationship. Method: This research is correlational in nature and applied in purpose. The statistical sample consists of 151 firms listed on the Tehran Stock Exchange during the period 2013 to 2023, selected through the screening method. To test the hypotheses, panel regression models with fixed effects were employed, using EViews 12 and Stata 17 software. Findings: The results of testing the first hypothesis indicate that financial flexibility has a positive and significant effect on investment efficiency. Firms with higher financial flexibility are able to allocate resources to profitable projects and avoid inefficient investment. This suggests that financial flexibility enables firms to effectively seize investment opportunities while mitigating the risks of inefficiency and potential bankruptcy. The results of the second hypothesis show that conditional conservatism weakens the positive effect of financial flexibility on investment efficiency. Firms that adopt more conservative financial reporting policies may not fully utilize their financial resources for investment opportunities. While conditional conservatism increases managerial caution, thereby limiting full exploitation of financial flexibility, it also contributes to preventing overinvestment and improving informational transparency. The results of the third hypothesis indicated that agency costs do not significantly affect the relationship between financial flexibility and investment efficiency. Robustness tests using two alternative measures-asset turnover ratio and free cash flow (FCF)-indicated that agency costs have a reinforcing effect based on asset turnover, while no significant moderating effect was observed with FCF. These results suggest that effective corporate governance and oversight in listed companies mitigate the negative impact of agency costs, limiting their influence on investment efficiency under conditions of adequate transparency. Conclusion: The study highlights financial flexibility as a key driver of investment efficiency, allowing well-capitalized firms to make more effective and lower-risk investment decisions. Conditional conservatism moderates this effect by limiting the full benefits of flexibility while reducing overinvestment risk. Additionally, effective corporate governance mitigates the negative impact of agency costs on investment efficiency. Based on the results, managers are recommended to optimize the mix of financing sources, manage liquidity efficiently, and strategically apply dividend and earnings retention policies to enhance investment efficiency. Investors can use the level of firms’ financial flexibility to manage financial risk and long-term returns, and policymakers can facilitate better utilization of financial flexibility by improving transparency and developing flexible financial instruments. Overall, this research provides empirical evidence on the relationship between financial flexibility and investment efficiency and offers practical guidance for managerial and investment decision-making, highlighting the importance of managerial and governance mechanisms in the optimal allocation of financial resources.

Keywords

References

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