Cashflow Investment Relationship: Empirical Evidence of Chinese Financial Market

Abstract: Purpose: In this study, we examine the data from Chinese companies to test the relationship between cash flow and investment. While a wide assortment of previous research has examined the relationship between cash flow and investment, they have largely focused on empirical analysis from an US or a Western perspective. But, to date, little attention has been paid to such relationship using empirical materials from a largely different Eastern context, such as China. Methodology: The econometric methodology is based upon a panel data setup, where Ordinary Least Square (OLS)- regressions with fixed and random effects were conducted. Investment is our dependent variable, whereas cash flow is the main explanatory variable. Apart from these two variables, for in-depth analysis, we also control for other independent variables: revenue, leverage, and Tobin's Q. Dummy variables are introduced, as well as an interaction term to test for effect of year and cashflow on investment. We take Year 2000-2010 as pre-Fintech era and Year 2011-2020 as post fintech era. Lastly, check the robustness of the models. Theoretical Perspectives: The theoretical perspectives of this study are derived from the regarding M&M theorem, Free Cashflow theory, Trade off theory, Pecking order theory, and Agency cost theory, and discuss how these relate to and affect each other and our variables. Empirical Foundation: Our main reference is Robert E. Carpenter and Alessandra Guariglia’s study from 2007 where they looked at cash flow-investment relationships by using panel data on UK firms. Some of our hypotheses are inspired from hypotheses that have already been empirically tested in this research paper, we are curious to see if the results differ with regard to Chinese companies. We also take Ascioglu et al.’s (2007) research as a base for our study since they used more direct measures derived from the market microstructure literature, such as debt and revenue, to observe the cash flow-investment sensitivity. Conclusions: Differing from the findings in previous papers– we find pre and post fintech era has impact on the relationship between cash flow and investment—as predicted we found that, when it comes to Chinese companies, cash flow has a positive relationship with investment. The effect of cash flow diminishes as other control variables- leverage, Tobin’s Q, and revenue are added. Explanatory variables- cashflow, Tobin’s Q and revenue have positive relation with investment, whereas Leverage has negative relation. All the variables are highly statistically significant except for Tobin’s Q.