Abstract
Under the premise of considering the motives and actions of all levels of governments, this paper empirically studies the mechanism and economic consequences of the law and order regulating inefficient investments on a sample of 3201 firm-year observations of listed companies in Shanghai and Shenzhen Stock Exchange in China over the period from 2007 to 2009. Using investment-cash flow sensitivities to proxy for inefficient investment of a company, I provide evidence that the degree of inefficient investments of listed companies controlled by local governments is much higher than that of other companies controlled by central government or non-governments. Furthermore, I find that the level of law and order of a region with high quality can reduce significantly the sensitivity of investment of Chinese listed companies to cash flows, the effect of which is much stronger for listed companies controlled by local governments. According to the conventional interpretations, a lower investment cash flow sensitivity means less investment distortions. However, the improvement of investment efficiency aising from the law and order are not ultimately transferred to the increase in the company’s future operating performances, suggesting that the roles of the level of law and order of a region across China playing in controlling company’s inefficient investment are limited.
Highlights
In a world where there are no tax and transaction costs and information is perfect, Modigliani and Miller (1958) have confirmed that a company’s investment decisions are irrelevant to its financing decisions, the market value of a company will be determined only by the future profitability of investment projects and cost of capitals that a company uses, and the company will achieve the maximum market value at the optimal level of investment
In order to further investigate the effect of government control on company investment efficiency and the role of rule by law playing in improving company investment efficiency, I further classify listed companies into those controlled by central government, local governments or non-government according to the nature of ultimate controller of a company and report regression results for each sub-groups in Table 2, 3 and 4, respectively
The reasons why financial constraints and agency conflicts give rise to company investments distorted and inefficient are largely related with laws lack of effective protection for investors’ rights
Summary
In a world where there are no tax and transaction costs and information is perfect, Modigliani and Miller (1958) have confirmed that a company’s investment decisions are irrelevant to its financing decisions, the market value of a company will be determined only by the future profitability of investment projects and cost of capitals that a company uses, and the company will achieve the maximum market value at the optimal level of investment. Feng Wei (1999), Zheng Jiangzhun, He Xuqiang and Wang Hua(2001), Wei Feng, and Liu Xing (2004) argue that the Chinese companies’ investment-cash flow sensitivities is mainly caused by the financial contraints in the capital markets, suggesting that there is underinvestment in company. He Jin’geng, and Ding Jiahua (2001), Zhang Yi, and Li Chen (2005) have found that investment-cash flow sensitivities in Chinese listed companies primarily arise from agency conflict problems, and overinvestments are main manifestations of inefficient investments of a company.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
