Cash flow, debt and the investment of Chinese listed companies —a theoretical and empirical analysis

Based on Chinese current system, this paper analyses theoretically and tests empirically the effect of internal cash flow and debt on the investment of listed companies in China. The research shows that underinvestment will occur in non-state-holding enterprises as well as in state-holding enterprises when free cash flow is low, corporate investment is sensitive to internal cash flow; however, when free cash flow is high, overinvestment will occur in both types of enterprises and their investments are sensitive to internal cash flow. For overinvestment or underinvestment, the investment is more sensitive to cash flow in non-state-holding enterprises than that in state-holding enterprises. Debt can constrain corporate overinvestment on the whole. Nevertheless, it makes underinvestment occur more frequently. Although short term debt does not promote corporate investment, it could constrain overinvestment. Bank loans do not play a role as contingent governance.