GEP 12/04: Does China overinvest? Evidence from a panel of Chinese firms

Summary

We investigate whether and why Chinese firms overinvest. We find that investment in China has become increasingly efficient over time. Yet, we also find evidence of overinvestment, which can be explained by the free cash flow hypothesis in the non-state sector, and by the poor screening and monitoring of enterprises by banks in the state sector.

Abstract

This paper uses a dataset of more than 100,000 firms over the period of 2000-07 to assess whether and why Chinese firms overinvest. We find that corporate investment in China has become increasingly efficient over time, which suggests that overinvestment has been declining. However, within all ownership categories, we find evidence indicating a degree of overinvestment by firms that invest more than the industry median. The free cash flow hypothesis provides a good explanation for China’s overinvestment in the collective and private sectors, whereas in the state sector, overinvestment is attributable to the poor screening and monitoring of enterprises by banks.

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Authors

Sai Ding, Alessandra Guariglia, and John Knight

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