Financial Development And Corporate Investment

How important is financial system in controlling the corporate investment decisions?This dissertation answers this question by linking the financial and real aspects of economy.The thesis of this dissertation is to determine how financial system's structure and its development influence the firm level investments when firm is having agency conflict as well as financial constraint and what lessons can be learnt from this for theoretical and practical usefulness.Present study presents the notion that financial development in an economy helps to reach towards optimal investments by reducing the likelihood of investment distortions.This manuscript holds the view and proves it empirically that financial development can help the firms to achieve an optimal level of investments in two ways:(i)reducing agency cost by efficient monitoring,(ii)lowering financing constraints by increasing flow of capital.This study contributes to the extant stream of financial literature by answering the question that whether agency issue and information asymmetric problem are resolved well in financial institution based or financial market based financial system.This study takes a prominent position in the extant literature due to its significance and uniqueness.The current manuscript is an important addition in the existing literature to build the relationship between financial and real sides of the economy.Considering the presence of information asymmetry and agency problem,the role of financial development and structure in determining corporate investment efficiency is quite a new topic for financial literature.None of the studies in extant literature has combined all these elements together.Our study is different from all conventional works because we have focused a single economy with all its characteristics rather than studying cross-county comparison after ignoring individuality between economies.Moreover,this study does not only discuss the agency cost,financing constraints and asymmetry information being the root causes under-and over-investments;but also suggest financial development and appropriate financial structure as remedy to achieve the optimal level of investments.Lastly,this study considers both types of investments i.e.capital investments and investments on technology innovation.This study also employs the innovative approach in methodology.Present study employs a robust empirical estimation by priori classifying the firms into financially constrained or financially non-constrained firms and firms having agency problem and firms without agency problem on yearly financial observations.Basic intention is to find out how explanatory variables determine the investment behavior of the firms in the scenario when firms have or have not financing constraints and agency problems.Moreover,to distinguish over-invested firms than that of under-invested,Study utilizes an already established accounting technique to priori classify the firms into firms suffering from under-investment or over-investment.This specification has helped us to analyze the in-depth impacts of the predictors,as we suppose that the behavior of under-invested firms is different than that of over-invested firms.This technique has also let us to determine whether financial development and financial structure impact the firms differently based upon intensity of financing constraints and agency cost.For analyzing investments on innovation activities specifically,this study has priori classified the firms on the basis of industry(high-tech and non-high-tech industry)and ownership(public,private,state and foreign owned).The empirical portion of the study is divided into three main parts.First part investigates the impact of financial development and financial structure on investment efficiency of the firms.Second part find the answer whether financial development in the economy may help the firms to reduce agency problem and financial constraints;and by this do they help the firms to shift under-and over-investment towards optimal investments.Third part finds the extent to which firms' technology innovation activities are affected by the financial structure of the economy.For the purpose of controlling potential endogenity of explanatory variables as well as accounting for firm specific and time invariant heterogeneity,we use generalized method of moments(GMM)which has the strength to estimate investments models by considering their dynamic nature.Study has also verified each and every estimation by various robustness techniques.The selection of Chinese economy as case study is purposeful because its financial system is undergoing fast development and financial structure is shifting from bank based to an equity based one.China has gained less consideration in largely available stream of financial literature that has stressed the association of financial constraints,corporate investments and innovation,maybe because of peculiar nature of its financial system,corporate structure and economy.Study presents a deep understanding of Chinese financial system and can diagnose shortcomings and suggest remedies.Study contains firm level and country level data to employ previously discussed empirical methodology.For the first part of the study,firm level data comprise of financial data from 2997 Chinese non-financial companies in years 1998-2015 listed in Shenzhen or Shanghai stock exchanges.For second and third part of the study,study period is between 2004 and 2015 because data for R&D expenditures were not available prior to 2004.This time period is important as this period is characterized by the development of financial legal system and corporate governance.All the data are drawn from RESSET,CSMAR and WIND databases.Later,data of financial institutions are excluded as the operating;investing and financing activities of these firms are distinct.Study also drops those all firms with less than three years of consecutive observations.Furthermore Winsorization technique is employed to eliminate the observations in 1%tails for variables to reduce potential influence of outliers.Due to differences in variables employed in three different parts of the study,three different samples are constructed.Results of the first part of the study show that financial development in China is helping the firms' investment efficiency by reducing investment cash flow sensitivity and by improving monitoring mechanisms.To test another transmission channel,study analyzes whether financial development increases investment response of Chinese firms to grasp growth opportunities.The answer revealed by this study is "Yes".Financial development in China strengthens the ability of firms to get benefit by growth opportunities.Even the firms suffering from the problems of financing constraints or agency,seem to respond these opportunities by increasing their investments.Thus,Chinese financial system is going in the right direction of development to produce a productive environment,which helps the firms to mitigate their financing and agency problems and helps the economy to grow fast.The overall result is that financial structure affects the investment behavior of firms.In case of this study,it is also disclosed that in China,market based financial structure has a positive effect on Chinese firms even when they have problems of financing constraints and agency.The study tests this notion by controlling the level of financial development.Results remain the same.The results reveal that capital market based financial structure can enhance the investment efficiency of Chinese firms by reducing their dependence upon internal finances and enhanced monitoring,and also enables the firms to furnish growth opportunities by increasing finances for investments.The second part of the study presents the snapshot of financial constraints and agency problems in China,giving a portrait on how firms'level investments slip either towards under-investment or over-investment.It is illustrated that the restricted access to finances(due to information asymmetry problem)leads to significant under-investment.On the other hand,the weak monitoring mechanisms lead controlling agents to go towards over-investment.This study presents the notion that financial development in an economy increases flow of capital and monitoring mechanism to overcome financial constraints and agency problems for firms in an economy,thus it can create a balance between under-and over-investment,which is considered optimal investments.The study provides empirical evidence over underpinning theoretical discussion that firms suffering from under-(over-)investment problem due to financing constraints(agency problem),increase(decrease)their investment expenditures when subject to financial development in the economy.Financial development diverts the growth path of under-and over-investment towards optimal investment by different mechanisms i.e.flow of capital and monitoring.As stated previously,the nature of investments on intangible assets is different than that of the investment on tangible and capital assets.Considering this fact,the third part of the study estimates the extent to which financial structure influences Technology Innovation Activities in China.Based on variety of firm level and industry level specifications and by employing panel data estimation techniques,we document that capital market based financial structure is the one which supports technology innovation activities more than bank based does.As regard to industry specification,results reveal that capital market based financial structure is influential to enhance TIA not only for high tech firms,but also for non-high tech firms.Firms owned by different entities,respond differently towards TIA influenced by financial structure.Private owned firms are the most active to absorb the potential benefits of capital market and show positive response towards it.Foreign funded firms are not related to local financial structure due to their funds flow from abroad.Due to the courtesy of state owned banking sector,SOEs do not find trouble to get financing for their technology innovation,although capital market also affects them positively.Moreover,we find that financial development in China is also facilitating the firms to grasp opportunities to expand their innovative activities.Study presents strong theoretical and practical implications for policy makers and firms managers.There's a need to create a balance between a credit-based system and a market-based one so that growth can be achieved by continuous support of government and efficient monitoring of capital market.The outcomes of financial development may be made more fortified by developing the corporate legal system along with the financial markets and institutions.There should be a change in the stance of government from paternalistic and authoritarian to a service oriented one.In order to grasp the blessings of financial development,firms may shift their dependency from banking system to equity markets system.Moreover,firms should provide transparent and timely information to the shareholders and creditors of the firm to reduce asymmetric information.Strengthening the governance mechanism may enhance the monitoring.