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How Do Misvalued Firms Deploy Internal Cash Flow?

We model how firms deploy internal cash flow across primary uses when they are misvalued in capital markets. All cash flow uses are jointly determined and interrelated by the accounting identity that the total sources of funds equals the total uses of funds. Our model predicts that, given an additional dollar of cash flow, more overvalued firms will allocate more to substitute for costly external financing and less to investment and cash savings. These predictions are confirmed empirically using an integrated regression framework that tracks all cash flow uses. Overall, our results imply that misvaluation affects corporate decisions and the real economy through an internal financing channel.