Free Cash Flow,Separation Of Control Right And Cash Flow Right,and Overinvestment

At the first session of the 13th National People's Congress in 2018,Premier Li Keqiang pointed out in his report on the work of the government that China's economy had changed from a stage of rapid growth to a stage of high-quality development.Over the past 40 years of reform and opening up,China's economy has undergone a long-term and rapid development.Its total economic output ranks second in the world and people's living standards have improved significantly.The economic system has also shifted from a single state-owned planned economy to a socialist market economy with Chinese characters.However,the phenomena of low investment efficiency,repeated construction and overinvestment still occur from time to time,which not only reduce the vitality and efficiency of the economy,but also harm the interests of small and medium-sized investors,which are in contradiction with the current requirements of high-quality economic development.This paper studies the problem of overinvestment of 2076 A-share non-financial listed companies in China from 2012 to 2017.Through Richardson's(2006)investment model,it is estimated that about one third of the companies in this period arc over-invested and two thirds are under-invested.In view of the fact that China's centralized ownership is relatively common and the pyramid structure prevails,which results in the separation of ownership and control rights of major shareholders,this paper studies the impact of free cash flow and the degree of separation of the two rights on overinvestment.It concludes that free cash flow increases the overinvestment of companies.However,unlike previous scholars' conclusion that the degree of separation increases overinvestment,this paper finds that the degree of separation reduces the abuse of free cash flow and then decreases overinvestment.For further study,this paper divides the company into central state-owned enterprises,local state-owned enterprises and other types of enterprises according to the nature of the company.It is found that only the degree of separation of local state-owned enterprises will increase overinvestment,while the degree of separation of central state-owned enterprises and other types of enterprises will reduce the abuse of free cash flow and decrease overinvestment.Analyzing the reasons behind,the local state-owned enterprises bear more policy burdens,such as regional economic growth and infrastructure construction,and have soft budget constraints,which motivate them to increase excessive investment.What's more,the separation will reduce the cost of occupying the interests of small and medium-sized shareholders.The separation of other types of enterprises(mainly consisted of private enterprises)increases their external financing constraints and therefore reduces the abuse of internal cash flow(i.e.free cash flow).Central state-owned enterprises do not need to undertake the task of local economic growth and then lack the incentives to overinvest.This paper also considers the impacts of the different provincial legal environments and different operational efficiencies.It is found that with better legal environments,managers or large shareholders abuse free cash less and there reduce overinvestment,and the interests of small and medium-sized investors are protected better.Companies with lower operating efficiencies,especially other types of enterprises,have higher risk preferences and agency problems,and then increase the positive correlation between free cash flow and overinvestment.