Is Investment-Cash Flow Sensitivity Caused by Financing Constraints or Agency Conflicts? Evidence from China

Based on a sample of Chinese listed companies, this paper explores the reasons for the relationship between cash flow and investment spending though examining the role of cash holdings on the investment-cash flow sensitivity. We find that the strong cash flow sensitivities of investment spending are indeed associated with companies' financing constraints or overinvestment of managerial discretions. The results suggest that the private enterprises and the large-sized local SOEs are more likely to over-invest, and higher levels of cash holdings play significant entrenchment effects and exacerbate the overinvestment behaviors of these companies. The results also imply that the small and medium-sized SOEs are suffered from financing constraints and their cash holdings act as a hedging device and mitigate the extent of financing constraints.