Government intervention and investment efficiency: Evidence from China

The extant corporate investment literature has documented that information asymmetry and agency conflicts between managers and outside investors prevent firms from making optimal investment decisions. In this study, we investigate whether government intervention, as another form of friction, distorts firms' investment behavior and leads to investment inefficiency. Using Chinese data, we test this by measuring government intervention at two different levels. First, we compare investment efficiency between SOEs and non-SOEs. We find that the sensitivity of investment expenditure to investment opportunities is significantly weaker for SOEs. Second, we measure government intervention by whether a firm is politically connected through the employment of top executives with a government background. We find that political connections significantly reduce investment efficiency in SOEs. However, we do not find such evidence in non-SOEs. Taken together, our findings suggest that government intervention in SOEs through majority state ownership or the appointment of connected managers distorts investment behavior and harms investment efficiency.     

Government intervention and firm investment: Evidence from international micro-data

Building on the important study by Beck et al. (2005), we examine how government intervention in firms' decision-making is related to their investment and sales growth. Using the unique World Bank dataset (WBES) covering 6500 firms in 70 countries, we find strong evidence that the extent of government intervention in firms' investment, employment, sales, pricing, dividend, and merger and acquisition decisions is negatively related to their investment and sales growth, with the effect being more profound in foreign owned firms and less significant in state-owned firms. The empirical results are robust to a series of robustness tests and instrumental variable regressions.     

Economic policy uncertainty and firm investment decisions: Dilemma or opportunity?

In an environment of economic policy uncertainty (EPU), how to improve efficiency and optimize the scale of firm investment is an important topic worthy of attention. This paper examines the impact of EPU on firms' investment decisions, using Chinese A-share listed companies from 2007 to 2019 as a research sample. The study finds that macro EPU inhibits the increase of firms' investment scale and efficiency while exacerbating the risk of overinvestment or underinvestment. Local EPU enhances a firm's investment scale but simultaneously exacerbates the risk of over- or underinvestment, which in turn inhibits investment efficiency. The mechanism test shows that, first, macro EPU promotes firms' R&D investment but inhibits their green investment. In contrast, local EPU inhibits R&D investment and promotes green investment. Second, macro EPU has a significant negative effect on firms' business performance, while local EPU has a smaller effect. Therefore, in an uncertain environment, the government should actively stabilize the macroeconomic environment, and firms should actively optimize investment structures and improve their risk prevention mechanisms.     

Institutional investors' site visits,information asymmetry,and investment efficiency

Based on data from Shenzhen A-share listed companies from 2012 to 2017, this paper studies the relationship between institutional investors' site visits (SVs) and corporate investment efficiency and its intrinsic transmission mechanism. Institutional site visits (SVs) can effectively mitigate firms' underinvestment, but it has no significant inhibitory effect on overinvestment. The conclusion still holds after using the instrumental variables and alternative measurements of investment efficiency. Mechanism analysis finds that site visits can alleviate underinvestment by reducing information asymmetry. We further document that the impacts are more pronounced for brokerages, funds, and private equity firms, firms with higher levels of internal governance, and firms' regions with better marketization. Our study suggests that institutional SVs mainly contribute to mitigating underinvestment rather than inhibiting overinvestment. This study provides practical insights for regulating corporate investment decision-making and is of significant practical significance for promoting the healthy development of enterprises.     

What provides the micro-foundation of monetary policies in the absence of mature economic institutions?

In the absence of mature economic institutions, what provides the micro-foundation of monetary policies? Taking corporate financing of China's firms as a representative example, first, our data suggest that financial access of firms becomes indeed squeezed as the monetary policies require. Then we confirm that government intervention leads firms' financial access to become difficult since the financial contraction policies. We also provide evidence that government intervention indeed promotes severity of access to finance. These evidences confirm that government intervention squeezes financial access after central government's financial contraction policies and that government intervention functions to support the implementation of monetary policies. Therefore, this paper shows that government intervention provides micro-foundation of the monetary policies in the absence of mature economic institutions.     

Do corporate tax cuts increase investments?

This paper studies the effect of corporate taxes on investment. Since firms with a foreign parent have more cross-country profit shifting opportunities than domestically owned firms do, their effective tax rate and, consequently, their tax-induced costs to investment are lower. We therefore expect capital investment responses to a corporate tax cut to be heterogeneous across firms. Using firm-level data on German corporations, we exploit the 2008 tax reform, which substantially cut corporate taxes as an exogenous policy shock and expect domestically owned firms' investments to be more responsive to the reform. We show exactly this in a difference-in-differences setting. We find that the reduction in corporate tax payments led to a one-to-one increase in the real investments of domestic firms. The effect is stronger for domestic firms relying more on internal funds. Correspondingly, labor investment increased more for domestic firms, ensuring a constant mix of input factors. In addition, we show that domestic firms' sales grew faster after the tax cut than the sales of foreign-owned firms. Our results imply that corporate tax changes can increase corporate investment but that domestic firms benefit more than foreign-owned firms from a tax cut through higher investment responses resulting in greater sales growth.     

Permanent sales increase and investment

When firms experience increases in sales that they consider to be permanent, the present value of expected profits also increases, leading to increases in the firms' investments. Our study investigates the permanent sales hypothesis (PSH) of firms' investment; it examines whether investment decisions are influenced by changes in the permanent, in contrast to transitory, component of sales income increases. Using the co-integration test and the structural vector auto-regression (SVAR) framework, our paper finds strong support for the hypothesis that investment behavior is primarily explained by permanent changes in sales income. Empirical multiple time series regression results also confirm that investments are a function of a number of past yearly sales changes. Our results show that larger, more liquid, and lower debt ratio firms follow PSH more closely than smaller, less liquid, higher debt ratio firms. Recent studies on corporate investment (i.e., Fazzari, Hubbard, and Petersen, 1988) have argued that the higher the dependence on the internal source of funding of the investment, the stronger the severity of financing constraints. Our study shows that the more dependent on the permanent cumulative increase of internal source of funding a firm's funding on investment, the less financially constrained firms.     

Shareholders' control rights,family ownership and the firm's leverage decisions

We investigate the association between controlling shareholders' ownership (CS_Own) and firms' leverage decisions in the Singaporean context. We examine whether the impact of ownership concentration on leverage differs across excess and lower control. We report that shareholders with excess control prefer leverage financing for an optimal capital structure and focus on value maximisation rather using leverage as a tool of minority shareholders' expropriation. Our analysis shows that firms capital structure significantly influences by the coalition of shareholders particularly decisions about leverage financing in addition to the firms' specific characteristics and institutional arrangements. Our empirical evidence shows that controlling shareholders with a lower fraction of equity are more concerned about limited holding thus prefer leverage over equity financing to inflate their equity stake to protect them from the potential takeovers and mergers. We report that capital structure decisions in Singapore are linked with the trade-off between the controlling shareholders' target of mitigating firm risk and their non-dilution entrenchment needs. Further, we found an inverted U-shaped association between control ownership and leverage financing. In terms of moderating effect of family-controlled ownership, our findings exhibit that leverage financing is less pronounced for family firms in Singapore due to the under-diversified investment portfolio.     

Do Key Audit Matters Affect Operating Activities? Evidence from Inventory Management

We investigate whether and how the disclosure of key audit matters (KAMs) affects firms' real operating decisions by examining the association between inventory-related KAMs and firms' inventory management. Exploiting China's recent audit report reform, our difference-in-difference analysis reveals that after the reform, inventory management efficiency increases more for firms subject to inventory-related KAMs than for other firms and the effect is more pronounced for industries in which inventory is material. Further analyses show that inventory-related KAMs positively affect inventory management by attracting external attention and increasing auditor monitoring, which in turn improves inventory management efficiency and operating performance. Our findings suggest that KAM disclosure changes firms’ managerial behaviours and generates a positive externality on real operations.     

Central supervision and earnings management: Quasi-experimental evidence from China

Earnings management is costly to society because it decreases the informativeness of earnings and hence distorts capital market efficiency. Drawing upon a natural experiment generated by the staggered random on-site inspection programme initiated by China's central government between 2013 and 2017, this paper finds that highly intensive central supervision significantly decreases local firms' earnings management behaviours. Moreover, the effect of central supervision is found to be more pronounced in provinces with severe GDP exaggeration, provinces with local governors facing impending promotion, and firms controlled by the government. These findings suggest that on-site inspections by the central government may alleviate local officials' political incentives and ability to pressure local firms to engage in earnings management. However, the estimation results of timing tests indicate that this monitoring effect is short-lived, calling for a more comprehensive strategy to enhance the supervision of local officials and consequently improve the reliability of firms' financial reporting quality. These findings highlight the importance of addressing the agency problem between central and local governments in curbing firms' earnings manipulation to improve the capital market efficiency of economies characterized by strong government intervention.     

The effects of operating cash flow disclosure on earnings comparability,analysts' forecasts,and firms’ investment decisions during the Pre-IFRS era

We examine the effects of the availability of operating cash flow (OCF) information disclosed by firms operating in 15 international countries during the pre-IFRS era on: (1) the comparability of these firms' disaggregated earnings to those of U.S. firms for equity valuation purposes, (2) the properties of analysts' earnings forecasts, and (3) the efficiency of firms' investment decisions. We find that the comparability of disaggregated earnings improves after company-disclosed OCF information is available. We also find decreases in analysts' forecast errors and dispersion and a decrease in firms’ tendency to over- or under-invest when they are predisposed to do so.     

Investment,leverage and political risk: Evidence from project-level FDI

Does capital structure influence firms' FDI capital expenditure decisions into countries with varying degrees of political risk? We explore this question using a novel dataset that matches 10,000 unique outward foreign direct investment (OFDI) projects with 1135 distinct U.S. firms over the period 2003–2014. We find that capital expenditures allocated to FDI projects are significantly lower for highly leveraged firms, in particular for firms with low growth opportunities. Firms also commit lower capital amounts to investments located in countries characterized by higher political risk. Furthermore, leverage and political risk interact with one another in determining the financial commitment of the FDI, with leverage exerting a significantly stronger negative effect on capital expenditures in countries where political risk is elevated. Our findings are consistent with the monitoring role of debt in curbing exposure to political risk in multinational firms' foreign operations, and corroborate the disciplinary role of leverage on firms' investment decisions.     

Do banks price environmental transition risks? Evidence from a quasi-natural experiment in China

This paper assesses the risk arising from transition toward a low-emission economy and examines its transmission channels within the financial system. The environmental dynamic stochastic general equilibrium (E-DSGE) model shows that tightening environmental regulation impairs firms' balance sheets in the short term, as it enforces firms to internalize the pollution costs, which consequentially escalates the risks facing the financial system. For the empirical analysis, we employ the Clean Air Action that the Chinese government launched in 2013 as a quasi-natural experiment. The analysis on a unique dataset containing more than one million loans indicates that the default rates of high-polluting firms rose by around 80% along their environmental policy exposure. Further analysis shows those joint equity commercial banks with lower degree of government intervention and better corporate governance structure were able to appropriately manage their exposure to transition risks, while the state-owned banks failed to factor in such risks when extending credit to the borrowers targeted by the environmental regulation.     

The Impact of Government Intervention on Corporate Investment Allocations and Efficiency: Evidence from China

We examine whether government intervention plays an important role in determining corporate investment allocations and efficiency in China. We find the government tends to intervene to promote corporate investment in fixed assets, equity in other state‐owned enterprises (SOEs), and natural resources including oil, natural gas, and mines, but reduces research and development (R&D) investment. However, the effects of government intervention on these investment allocations are primarily found in local SOEs rather than in central SOEs or in private enterprise. Government intervention also induces a crowding‐out effect in natural resource investments of private firms, suggesting that government intervention distorts investment allocations and reduces investment efficiency.     

Vertical merger,R&D collaboration and innovation

This paper studies the effects of vertical merger and R&D collaboration activities on firms' innovation decisions and stock returns based on a continuous-time real option model under market and technological uncertainties. Our analysis confirms vertical merger's benefit in amplifying the potential gain from innovation through eliminating inefficiencies. We show that vertical merger boosts innovation incentives in two ways: it reduces the optimal innovation threshold when firms suspend the project and increases R&D investment when firms launch the project. If vertical merger is not possible, R&D collaboration can improve firms' innovation levels as an alternative decision, but inefficiencies still exist which implies less pronounced stimulation effects. Both vertical merger and R&D collaboration can reduce firms' risk when conducting innovation project and weaken the positive R&D-returns relation and financial constraints-returns relation, while these effects of vertical merger are stronger than those of R&D collaboration.     

The impact of abnormal real earnings management to meet earnings benchmarks on future operating performance

Motivated by agency conflicts of real earnings management (e.g., opportunistic and signalling perspectives), this study investigates the association between firms that manipulate their business operations to meet earnings benchmarks (i.e., zero earnings, last year's earnings) and subsequent operating performance. We examine the effects of the magnitude of real earnings management on firms' future performance for the period 2009 to 2015 for UK firms. Our analysis shows that the manipulation of operating activities such as sales, discretionary expenditures, and production costs to meet earnings benchmarks has a significantly positive consequence for firms' subsequent operating performance and signals firms' good future performance. We also find that firms that manipulate their operating activities in the absence of meeting earnings benchmarks experience a decline in their subsequent operating performance. The findings of this research lend support to our understanding of the process that management follows to evaluate costs and benefits of real earnings management.     

Green credit policy and corporate cash holdings: Evidence from China

In 2012, China implemented a green credit policy (GCP) that restricts bank credits to heavily polluting firms. Using a difference-in-differences research design, we find that polluting firms increased their cash reserves by 9.5% after the GCP's issuance relative to non-polluting firms. We also document that the GCP significantly reduces firms' access to bank finance but increases the value of cash. Cross-sectional analysis shows that the increase in cash holdings is more significant for firms with greater financial constraints, firms with more investment opportunities, and high-tech companies. Overall, our findings are consistent with a constraint explanation: when external financing is restricted, firms retain more cash to meet future investment needs.     

Government Intervention and Investment Comovement: Chinese Evidence

This study examines whether government intervention affects corporate investment comovement, and whether this impact varies across firms with different types of ownership. We use a large Chinese sample to investigate these questions, and perform a regional as well as firm‐level analysis. We show that government intervention is positively and significantly associated with investment comovement. We also find that the impact of government intervention on investment comovement is higher and more significant for state‐owned firms than for domestic private and foreign firms. Finally, we show that investment comovement hinders corporate performance for state‐owned and domestic private firms but not for foreign firms.     

Depoliticization and corporate cash holdings: Evidence from the mandated resignation of directors in China

The 2013 depoliticization regulation (Rule 18) in China mandates government officials to resign from board positions in public firms, terminating firms' political connections established through these directors. Exploiting this regulation as a quasi-experiment, we document that politically connected firms increase their cash holdings 12.7% more than non-connected firms because of these resignations. This pattern is more pronounced among firms that rely more heavily on the government for external resources. Among state-owned firms, the pattern is more evident in firms that are more deeply privatized. In addition, firms that lose political ties experience a significant decline in obtaining bank loans and government subsidies, and they are also slower to adjust their cash holdings toward the optimal level. These findings underscore the role of corporate political linkages in facilitating firms' access to resources that “soften” firms' budget constraints.     

Effects of Foreign Presence in a Transition Economy: Regional and Industrywide Investments and Firm-Level Exports in Ukrainian Manufacturing

We investigate the effects of regional and industrywide foreign presence and foreign direct investment (FDI) on the export volumes of Ukrainian manufacturing firms using unpublished panel data from 1996-2000. Foreign presence through FDI may have negative competition effects on domestic firms' performance; at the same time, domestic firms' productivity may be increased by technology transfer or training and demonstration effects. From a Cournot competition model that includes negative competition and positive technology spillover effects, we hypothesize that foreign presence and FDI might positively affect domestic firms' output and exports. Our estimation results support these hypotheses, suggesting in particular that large firms and durable goods producers benefit most from foreign presence and investments.