Overinvestment and corporate governance in energy listed companies: Evidence from China

Abstract

Driven by subsidies policy and energy-finance integration, China's energy firms are awash with free cash flow. So far, China is the largest energy investment destination and investors in the world. In this context, we need to think whether such large amount of investment is truly proper, or does free cash flow lead to over-investment, and whether corporate governance can help to eliminate the over-investment. This letter examines the sensitivity between free cash flow and over-investment in China's energy listed companies. We also investigate whether corporate governance mechanism can help to reduce agency problem, thus to reduce such sensitivity. By employing Richardson (2006) investment expectation model, we are able to measure over-investment and free cash flow simultaneously and estimate the sensitivity between them. We choose board of directors and ownership structure to represent corporate governance mechanism and introduce them into regression model to check how each mechanism works. Our results find that free cash flow will significantly positive affect over-investment. No effective corporate governance mechanisms can help to mitigate the significant sensitivity between free cash flow and over-investment, while board shareholdings and state shareholdings would significantly increase the sensitivity between free cash flow and over-investment.