I explore a new aspect of financial flexibility – namely, the ability of a firm to adjust its
internal and external sources of financing for corporate investment in response to financial
market mispricing. I analyse the joint impact of accessibility to external financing and stock
mispricing on the sensitivity of investment to internal cash flows. Using a large sample of US
manufacturing firms over the period 1971-2008, I find that firms with greater access to
external capital markets are more flexible in adjusting their sources of financing for corporate
investment in response to mispricing. Specifically, firms with greater access tend to have
lower (higher) investment-cash flow sensitivities in situations of overvaluation
(undervaluation). In contrast, the investment-cash flow sensitivity of firms with limited
access to external finance is negligibly affected by the level of mispricing.
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