TITLE:
Product Market Competition and Financial Flexibility: Evidence from China
AUTHORS:
Xinghe Liu, Ziyi Chen, Xinbao Yang
KEYWORDS:
Product Market Competition, Spare Debt Capacity, Excessive Cash Holdings
JOURNAL NAME:
Modern Economy,
Vol.11 No.7,
July
27,
2020
ABSTRACT: This paper discusses the effects of product market competition
on the value and level of corporate financial flexibility of Chinese listed
firms for the period 2001-2014. We use three different measures of product
market competition: predation risk, natural hedge and price-cost margin.
Predation risk is used to measure how firms’ growth opportunities covary with
those of their industry rivals. We thus calculate the correlation of firm stock
returns with industry stock returns. The regression coefficient on the industry
return is then used as the proxy for predation risk. Greater values of this
measure indicate a greater predation risk, more interdependence of investment
opportunities and therefore fiercer competition. Natural hedge is calculated as
the absolute value of the difference between a firm’s ratio of net fixed assets
per employee and the median ratio in the industry. To make this difference
comparable across industries, the difference is then scaled by the industry
range of the capital-to-labor ratio. Smaller values of this measure indicate
greater similarity of a firm’s operations with industry counterparts and
therefore signal fierce competition. The results show that when the other
conditions remain unchanged, the predation risk weakens the spare debt capacity
and excessive cash holdings and ultimately decreases corporate financial
flexibility. Except for the natural hedge used to measure the degree of product
market competition, which does not significantly affect spare debt capacity,
the other results show that natural hedge reduces excessive cash holdings and
corporate financial flexibility. On the one hand, product market competition
increases the demand for financing; because Chinese listed firms are subjected
to China Securities Regulatory Commission (CSRC) supervision for issuing
securities, they must increase debt and reduce their spare debt capacity. On
the other hand, product market competition increases investment expenditure,
consumes cash, and reduces excessive cash holdings. In the end, product market
competition reduces corporate financial flexibility.