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.