Free cash flows and overinvestment: Further evidence from Chinese energy firms

Abstract

In the recent years, Chinese energy firms have accumulated significant free cash flows due to higher energy prices and government subsidies and also have invested heavily. An important empirical question is whether the Chinese energy firms tend to misallocate resources due to growing free cash flows. In this paper, we test whether they make some sub-optimal investment decisions following the well-established free cash flow problem in the finance literature, originally identified by Jensen (1986) for the US oil sector. Using a dynamic panel model for the period 2001–2012 for the Chinese energy-related public listed firms, we find evidence supporting the free cash flow hypothesis, suggesting overinvestment problems in the Chinese energy sector. In addition, we observe that firm size and corporate governance structure are important determinants of the Chinese energy firms' investment decisions.