Corporate financial constraints and investment efficiency in the presence of market frictions

This study examines how corporate financial constraints affect investment efficiency in the presence of market frictions. While prior literature has extensively analyzed financial constraints and investment efficiency separately, limited attention has been given to how market frictions influence the extent to which constrained firms allocate capital efficiently. Using a balanced panel dataset of 280 firms across six countries over the period 2013–2024, this study employs a quantitative panel regression framework to investigate the relationship between financial constraints and investment efficiency under varying levels of market frictions. The empirical results indicate that financial constraints significantly reduce investment efficiency, leading to both underinvestment and overinvestment due to suboptimal capital allocation. Market frictions such as information asymmetry, higher transaction costs, and limited access to external financing further intensify this negative relationship. Additional analysis suggests that firms with stronger governance structures and higher managerial efficiency are better able to mitigate the adverse effects of financial constraints, thereby improving investment efficiency even in the presence of severe market frictions. Overall, the findings highlight that investment efficiency is shaped not only by internal financial capacity but also by external market conditions and institutional environments. This study contributes to the literature by integrating insights from the Resource-Based View and market frictions theory to explain corporate investment behavior under financial constraints. The findings offer important implications for policymakers and managers by emphasizing the need to reduce market frictions and strengthen internal governance mechanisms to enhance efficient capital allocation in financially constrained environments.