An Empirical Study On Ownership Structure, Free Cash Flow And Over-investment

Agency cost of free cash flow theory is that when the cash flow of the enterprises within is ample, managers will do over-investment opportunism behavior. For the governance mechanism of over investment of free cash flow, scholars have carried out extensive research from different angles. This paper focuses on the governance effect of ownership structure, a kind of internal corporate governance mechanism, on over-investment of free cash flow. The purpose of corporate governance mechanism is to ensure that capital providers will be able to get a return on investment, prevent managers from lazy, on-the-job consumption behavior, and to ensure that managers make business decision in the shareholders’ position. As an integral and important part of the company governance mechanism, what role has the ownership structure has played on over-investment of free cash flow is research purposes of this.This paper selects Shanghai and Shenzhen A-share listed companies from 2003 to 2013 as samples, to study the governance effect of three kinds of investors’ shareholding, i.e. the ultimate controlling owner, institutional investors, senior managers, on over-investment of free cash flow. Based mainly on the supervision effect and entrenchment effect of controlling shareholders, this paper analyzes what impact of the ultimate controlling owner’s shareholding on over-investment of free cash flow. The research results show that the increase of the ultimate controlling owner’s shareholding does not play the oversight role, but the entrenchment effect, i.e. it aggravates the over-investment of free cash flow, and strengthens the controlling shareholders’ encroaching on the interests of small and medium shareholders; Based on the monitoring hypothesis and the strategic alliance theory, this paper explores the role of institutional investors’ shareholding on the over-investment of free cash flow. The results support the strategic alliance theory, which means that self-interest institutional investors would choose to support managers’ opportunism behavior, if they predict the benefits of collusion with managers. Based on the alignment effects, this paper explores the impact of the senior managers’shareholding on over-investment of free cash flow. The results confirm that the increase of the senior managers’ shareholding is beneficial to alleviate the conflict of interest between investors and managers, to reduce the over-investment of free cash flow behavior.The possible contribution of this paper is:the existing papers mainly explore the ownership structure’s governance effect of over-investment of free cash flow from the following aspects, i.e. ownership concentration and equity restriction ratio. This paper selects three kind of investor shareholding (i.e. the ultimate controlling owner, institutional investors, and senior managers) to measure ownership structure, and further explores their impact on over-investment of free cash flow. On the one hand, the results can open the black box of the ownership structure’s effects on over-investment of free cash flow, and find the influence of insider ownership (including the ultimate controlling owner and senior managers) and external investor shareholding (institutional investors) on over-investment of free cash flow. On the other hand, the results can enrich the documents of the governance mechanism of over-investment of free cash flow to some extent.This paper is organized as follows:the full text is divided into six parts. The first part is the introduction, which describes the background, the significance and innovative points of this research. The second part is literature review, which consists of five parts:over-investment of free cash flow, ownership structure and over-investment of free cash flow, the governance effect of large shareholders’ holding, institutional investors’ shareholding and senior managers’shareholding, respectively. The third part is theoretical analysis and research hypotheses, the entrenchment effect, the monitoring hypothesis, the strategic alliance theory, and the alignment effects are basis of a series of hypotheses. The fourth part is the empirical research design, which will describe the models, the sample selection, the data sources and the process of over-investment calculation. The fifth part shows the empirical results and the corresponding analyses. Last but not the least is the relevant conclusions and possible policy recommendations, followed by the defects and further study of this paper.