Abstract

Under the premise of considering the motives and actions of all levels of governments, this paper empirically studies the mechanism and economic consequences of the law and order regulating inefficient investments on a sample of 3201 firm-year observations of listed companies in Shanghai and Shenzhen Stock Exchange in China over the period from 2007 to 2009. Using investment-cash flow sensitivities to proxy for inefficient investment of a company, I provide evidence that the degree of inefficient investments of listed companies controlled by local governments is much higher than that of other companies controlled by central government or non-governments. Furthermore, I find that the level of law and order of a region with high quality can reduce significantly the sensitivity of investment of Chinese listed companies to cash flows, the effect of which is much stronger for listed companies controlled by local governments. According to the conventional interpretations, a lower investment cash flow sensitivity means less investment distortions. However, the improvement of investment efficiency aising from the law and order are not ultimately transferred to the increase in the company’s future operating performances, suggesting that the roles of the level of law and order of a region across China playing in controlling company’s inefficient investment are limited.

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