| The topic of the relationship between investment and financing has become the focus of theoretical research, which can help to rectify the non-efficiency in investment and improve the capital market, so analyzing how financing affects investment has important significance.Cash flow is the company’s internal sources of financing, Jensen (1986) and Fazzari, Hubbard and Petersen (1988) studied the relationship of investment and cash flow based on agency problems and asymmetric information, and formed two main theory--free-cash-flow theory and financing constraints theory of asymmetric information. However, the two main theories have respectively angles on how cash flow affects investment. Free-cash-flow agency theory suggests that managers seek their own interests by expanding the scale, due to management opportunism. They use cash flow on investing the project which should have paid dividends to stockholders, which even leads to negative net profit value. Management intends to expand investment if they own too much cash flow, resulting in high investment-cash flow sensitivity; Asymmetric information theory suggests that external investors demand compensation due to the risks posed by asymmetric information (Myers and Majluf,1984), resulted a higher external finance costs than internal financing for company. For this reason, company prefers to cash flow when need to invest. To companies facing serious financial constraints, it maybe leads to insufficient investment because of lacking of cash flow, and finally shows high investment-cash flow sensitivity.Regardless of insufficient invest or over-invest, they all belong to non-efficiency investment, and it reflects imperfect capital market such as agency problems or asymmetric information. To improve the efficiency of investment, government must focus on major problems because of the relatively short history of China’s capital market. So what leads to the correlation of investment and cash flow? Is it information asymmetry or agency problems? And with the continuous development of China’s capital market, whether the reason will change or not? Recently, Premier Li Keqiang says government will keep launching new initiatives to promote financial reform in the multi-level capital market, and whether the policy will ease financing constraints or lead to over-investment? This paper intends to test how cash flow affects investment, this may do help to rectify the non-efficiency of investment and improve the capital market.The article will conduct research between investment and cash flow based on pay-performance sensitivity. This is because, pay-performance sensitivity reflects the approaching of the shareholders’and management’ interests. From the point of free-cash-flow agency theory, manager expands investment to seek their own interests because of management opportunism. However, with the closer of manager’s interests and shareholder’s interest, manager recognizes that the behavior of damaging value of company finally does harm to themselves. Thus, manager will reduce over-investment, investment-cash flow sensitivity drops; from the point of asymmetric information theory, with the closer of manager’s interests and shareholder’s interests, manager will prefer cash flow to invest on the standpoint of shareholder because of the inflated cost of external funds, thus it leads to higher investment-cash flow sensitivity. So we can see that, as the closer of manager’s interests and shareholders’ interests, the directions of investment-cash flow sensitivity’s change are different in two main theories. As indicator of the closer of manager’s interests and shareholders’interests, with pay-performance sensitivity increases, must it be consistent between the interests of management and shareholders? Based on pay-performance sensitivity perspective, what will be the conclusion about the relationship of investment and cash flow in China?Meanwhile, because of China’s special institutional background, the investment behavior and financing environment is not the same in the state-owned holding companies and non-state-owned holding companies. For the state-owned holding companies, there are six steps from the shareholders to management: People-the Country-State-owned Assets Management Department-State-owned Assets Management Company-Board of Directors-manager. as the level increases, property rights are not protected. Absence of ownership leads to management opportunism, management is more likely to over-investment in pursuit of private gain; for non-state-owned holding companies, it is highly probable to face financial constraints. This is because, initially, China’s capital market is not developed, non-state-owned holding companies cannot raise too much funds because of its high risk considered by bank. From the respective of agent problem, with the closer of management and shareholders’ interests, investment-cash flow sensitivity will drop; however, from the respective of asymmetric information, the investment-cash flow sensitivity will increase. Therefore, based on the perspective of pay-performance sensitivity, through the change of investment-cash flow sensitivity can test the causes of non-efficiency of state-owned holding companies and non-state-owned investment holding company.In this article, I choose China’s A-share listed companies’ sample data in2005-2011, and study the correlation of investment and cash flow and the nonlinear relationship of pay-performance sensitivity and investment-cash flow sensitivity by correlation test and multiple regression analysis. Meanwhile, based on special institutional context, I also analyze whether the nature of ownership will affect the correlation of investment and cash flow. The main conclusions are:(1) Investment is positively correlated with cash flow. Regardless of2005-2011all samples or sub-samples, with the increase or decrease in cash flow, investment will be a corresponding change, and the conclusion indicates that in China investment is correlated with financing sources. As well, no matter what state-owned holding companies or non-state-owned holding companies, investment and cash flow were both positively correlated.(2) There is non-linear relationship between pay-performance sensitivity and investment-cash flow sensitivity. I divide pay-performance sensitivity into four groups, and find that investment-cash flow sensitivity of the lowest group and the highest group is higher than the lower and the higher. With the increase of pay-performance sensitivity, investment-cash flow sensitivity initially decreased and then increased, there is non-linear relationship between pay-performance sensitivity and investment-cash flow sensitivity.(3) For state-owned holding companies, the correlation of investment and cash flow is mainly caused by the agency problems; for the state-owned holding companies, information asymmetry leads to the correlation, but with the development of China’s capital market, financing constraints eased for the non-state-owned holding companies, agency problems lead to investment and cash flow as well. Through a phased research on the correlation of investment and cash flow, I do find from2005to2006, the state-owned holding companies have serious agency problems, resulting in high investment-cash flow sensitivity. However, from2005to2008, the non-state-owned holding companies are facing strong external financing constraints, showing high investment-cash flow sensitivity, but from2009to2011, with the development of capital markets, financial constraints have been alleviated, agency problem also leads to high investment-cash flow sensitivity for non-state-owned holding companies.(4) Compensation Regulation exists in state-owned holding companies. For state-owned holding company, pay-performance sensitivity almost has no change through statistical analysis from2005to2011. but as index of company performance, the sales multiplier and cash flow have more obvious fluctuations, this illustrates that no matter company performance is rising or falling, the remuneration of the management does not change much in the state-owned holding companies, compensation regulation exists; for non-state-owned holding companies, pay-performance sensitivity rise year by year, and vary between companies, this shows that the remuneration of the management do differ in non-state-owned holding companies.The correlation of investment and cash flow means non-efficiency investment, it also reflects the imperfect capital market. The article draws the conclusion that there is non-linear relationship between investment-cash flow sensitivity and pay-performance sensitivity, then tests which one can explain more powerful in two main theories, so the conclusion clearly reveals how cash flow affects investment. Meanwhile, taking the institutional context and developments of capital market of China into account, the article also inspects the relation between investment and cash flow for both state-owned holding companies and non-state-owned holding companies. This not only enriches the theory research on investment and financing, but also provides proposals to rectify the non-efficiency investment and improve the capital market, which has practical significance for enhancing the value of the company and deepening capital markets reform. |
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