The Effects of Financing Status on Firm Behavior:
The China Experience

Abstract

In this thesis, we investigate the impact of firms’ financial conditions on three key corporate activities: fixed capital investment, cash holdings, and acquisition behavior. Our study provides an important extension to the related literature in the Chinese context by employing a 14-year panel of Chinese listed firms during the period 1998-2011.
In chapter 2, we investigate the sensitivity of abnormal investment to free cash flow. First, we find that firms with free cash flow below (above) their optimal level tend to under- (over-) invest, which can be attributed to financial constraints (agency costs). We also find that significant heterogeneity in the sensitivities appear among firms with different financial conditions, ownership structure. Whether or not firms engage in exporting or Mergers & Acquisitions also affects the sensitivities. Additional analyses show that the 2005 exogenous split share reform reduced the agency problems faced by state controlled firms, particularly those controlled by local governments.
In chapter 3, we focus the behavior of corporate cash holdings. We find evidence supportive of a cost-benefit trade-off model of cash holdings, suggesting that Chinese firms tend to actively manage their cash balances towards a target level. Reported evidence also shows that consistent with the presence of adjustment costs, there exists considerable heterogeneity in adjustment speeds of cash holdings across firms. Furthermore, we show that cash-rich, acquiring, and state-owned firms are characterized by a lower value of additional cash. At the same time, financially constrained firms have a higher marginal value of cash, suggesting that more difficulties in accessing capital markets encourages firms to make better use of additional cash.
In chapter 4, we investigate the extent to which corporate liquidity affects Chinese listed firms’ acquisition decisions, method of payment choices, and consequent performance following mergers. In line with the free-cash-flow motive of acquisitions, we find that cash-rich firms are more likely to attempt acquisitions. Furthermore, the agency costs effect of acquisitions is greater for firms who are subject to tunneling. Finally, we provide empirical evidence to support the fact that financially constrained firms with higher growth prospects tend not to use cash payments in acquisitions. We attribute this finding to the higher opportunity cost of cash faced by firms who face more difficulties in accessing capital markets. This finding is consistent with the under-performance of cash acquisitions in both the short and long-term.