69 Pages Posted: 18 Sep 2011 Last revised: 17 Feb 2012
Date Written: January 4, 2012
This paper explores reasons for the excess sensitivity of (under- or over-) investment to free cash flow. Using accounting information from Chinese listed firms, we find robust support for the fact that higher sensitivities of abnormal investment to free cash flow can be caused by financial constraints or agency costs. The evidence suggests that firms with free cash flow below their optimal levels tend to under-invest due to financial constraints. Moreover, firms whose free cash flow exceeds the optimal level are more likely to over-invest due to agency costs. Evidence from the exogenous split share structure reform via a DID approach confirms that both financial constraints and agency costs led firms’ investments to become inefficient. We also find that there exists some heterogeneity in the degree of financial constraints and agency problems faced by firms according to ownership structures, location and whether they engage in exporting or cross-listing.
Keywords: Investment Inefficiency, Under- or Over- Investment, Free Cash Flow, Financial Constraints, Agency Costs
JEL Classification: G31, G34, O16, O53
Suggested Citation: Suggested Citation
Yang, Junhong and Guariglia, Alessandra, Is Investment Inefficiency Caused by Financial Constraints or Agency Costs? Evidence from Chinese Firms (January 4, 2012). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1928021 or http://dx.doi.org/10.2139/ssrn.1928021