Ultimate Control, Internal Cash Flow And Corporate Investment Behavior

Since the core of corporate governance research has advanced to Principal-Pricipal Conflicts, it has been a major focus on the mechanism of how the ultimate controlling shareholder deprives the interest of minority shareholders. Research on investment is an effective way to explore this kind of phenomenon as it has always been the source of profit creation. In the background of economic transition, we can found trails of all kinds of abnormal investment triggered by the controlling shareholders due to the popularity of ownership concentration. Examples are the governments’interference of the state-owned enterprises (SOEs), especially those of local governments. In recent years however, family enterprise, representative of the private listed companies, has gained larger proportion of the capital market, which makes it worthwhile to pay close attention to the heterogeneity on the investment behavior between SOEs and family enterprises.After combing the existing literature systematically, this paper use nonlinear relationship between investment and cash flow as the breakthrough point, based on free cash flow hypothesis, verified the following questions through theoretical analysis and empirical test.1. The influence on listed company investment by ultimate controlling shareholders with different nature of property right.2. How do family controlling shareholders influence listed company investment if they are in management position.3. The influence on listed company investment with different separation degree of control and cash flow right.Yet different with previous investigation, this paper found the relationship between investment and cash flow is non-linear. Specifically, State owned listed firms have a U-shape relationship between investment and cash flows, representing a higher inclination of overinvestment due to reasons like government intervention, promotion motivation and escalation of commitment etc. Meanwhile, family enterprises have a unilateral linear relationship between investment and cash flow. Family enterprises have a positive relationship between investment and cash flow when cash flow is positive, with a lower sensibility compared to SOE. When cash flow is negative, however, investment and internal cash flow are uncorrelated. The phenomenon represents the internal cash flow has been the capital source to grab control of self-interest by family controlling shareholders. The extent of overinvestment is much stronger when the companies’ ultimate controlling shareholder is the government. Further analysis with the state-controlled companies has found that the U-shape relationship between investment and cash flow mainly originates from local governments while central government owned companies have a unilateral linear relationship between investment and cash flow. Overinvestment is deteriorative when the company is owned by local government. Further analysis with the family enterprises also found that when "entrenchment effect" dominates, family members in management position will induce excessive investment, using internal cash flow. Moreover, when the divergence between control rights and cash-flow rights, the tendency of overinvestment by family enterprises and central-government owned companies is higher, and the unilateral linear relationship is more obvious. Surprisingly, however, this paper found that the divergence between control rights and cash-flow rights does not affect the local government investment behavior.