The impacts of cash flow volatility on Chinese firms: investment, debt maturity, cost of capital

This thesis attempts to investigate cash flow volatility on Chinese listed firms. It mainly consists of three empirical chapters on the relation between cash flow volatility and Chinese firms' investment, debt maturity, cost of capital. The first empirical chapter examines the relation between cash flow volatility and investment by Chinese listed firms. I find that, in China, cash flow volatility is negatively related to firms’ investment. This effect of cash flow volatility is obvious for financially constrained firms. However, for financially unconstrained firms, the effects of cash flow volatility are relatively less importance. I also find that the market-to-book ratio has a greater impact on the sensitivity of investment to cash flow volatility than other proxies of financial constraints. Finally, financially constrained firms hold more cash to smooth cash flow, while financially unconstrained firms do not increase cash holdings when they experience high cash flow volatility. The second empirical chapter examines the relation between cash flow volatility and the debt maturity of Chinese listed firms. The findings of this chapter show that cash flow volatility does not affect the debt maturity of Chinese firms. As the dependent variables are proportional or fractional variables, I introduce two kinds of fractional response models. The first follows the Papke and Wooldridge (1993), while the second is an extension of the fractional response model proposed by Wooldridge et al. (2011). For the robustness tests, I use the Tobit model, OLS and the Fixed Effects model to estimate the specification. All the results demonstrate that cash flow volatility does not affect the debt maturity of listed Chinese manufacturing firms. The last empirical chapter investigates the impact of cash flow volatility on the cost of capital in China, distinguishing between the cost of debt and the cost of equity. Four methods are introduced to measure the cost of capital. The industry method (Gebhardt et al., 2001), the PEG ratio (price-earnings ratio divided by short-term earnings growth rate) proposed by (Easton, 2004), and the average of these two methods (PEG ratio and industry method) are used to measure the cost of equity. The measure for the cost of debt is based on the method in Chen and Zhu (2013). To estimate the models, I use two different methods: Fama-Macbeth adjusted using a Newey-West procedure and OLS (clustering by firms). The empirical results show that cash flow volatility increases the cost of equity in China, while the cost of debt is not affected by the volatility of cash flow. The reason for the cost of debt not being affected by cash flow volatility is due to the immature bond market in China. Finally, this chapter finds that while state ownership decreases the cost of debt, it does not affect the cost of equity.