Institutional Environment, Loan Covenant And The Abuse Of Free Cash Flow

In the post crisis era, many C hinese enterprises have suffered from serious excess capacity and even direct bankruptcy. The enterprise financial crisis led to the rise of bank non-performing loans rate. This means that debt contract is mainly for the financing function. In the transition economy, understanding how the debt contract plays a role of effective governance is an empirical proposition.Using the data of C hinese A-share listed companies between 2003 and 2013 as the research sample, combined with C hinese unique institutional environment, this paper studies the agency problem of the excessive investment abuse of free cash flow from the perspective of loan covenants debt governance. From four dimensions of the contract terms, contract environment, the subject of contract supervision and corporate characteristics, this paper specifically discussed the following problems: First, whether loan contract would control the excessive investment of free cash flow and whether the governance role would show significant differences in different institutional environment. Second, whether the contract terms is a necessary complement to the loan contract in the governance effect. Third, whether loan contract governance effect from different contract supervision subject will reflect significant differences. Fourth, the relation of governance role between internal corporate governance and loan contract on free cash flow is alternative or complementary. Through theoretical analysis and empirical test, it is found that:First, there are the agency costs of the excessive investment abuse of free cash flow in C hinese companies. Overall, the governance effect of loan contract on free cash flow is not significant. In different institutional environment the governance effect reflects the obvious difference: in the area with the faster marketization process, the weaker government intervention and the higher level of legal protection, loan contract governance effect is more significant.Second, in the area with the rapid process of regional marketization, the rise in interest rates would strengthen the governance effect of loan contract; in the area with the slow process of regional marketization, the rise in collateral loans proportion would strengthen the governance effect. That means interest and mortgage term play a complementary role in governance effect of the loan contract.Third, with the increase in the number of the Subject of Contract Supervision, the governance effect of loan contract is stronger. Compared with other bank loans,joint-stock commercial bank loans don’t reflect stronger governance effect.Fourth, by improving the internal corporate governance, the governance effect of loan contract on abuse of free cash flow is significantly strengthened in the area with the rapid process of regional marketization. The internal corporate governance plays a complementary role for the governance of loan contract.These finds not only enrich the study of overinvestment of free cash flow and consequences of debt governance of bank loan contract, but also may have some implications for standardized management activity, corporate governance and prevention of financial risks.