Monetary policy and dynamic adjustment of corporate investment: A policy transmission channel perspective

Fu, Qiang; Liu, Xing Article Monetary policy and dynamic adjustment of corporate investment: A policy transmission channel perspective China Journal of Accounting Research Provided in Cooperation with: Sun Yat-sen University Suggested Citation: Fu, Qiang; Liu, Xing (2015) : Monetary policy and dynamic adjustment of corporate investment: A policy transmission channel perspective, China Journal of Accounting Research, ISSN 1755-3091, Elsevier, Amsterdam, Vol. 8, Iss. 2, pp. 91-109, https://doi.org/10.1016/j.cjar.2015.03.001 This Version is available at: https://hdl.handle.net/10419/187639 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ Monetary policy and dynamic adjustment of corporate investment: A policy transmission channel perspective Qiang Fu, Xing Liu ⇑ School of Economics and Business Administration, Chongqing University, China ARTICLE INFO Article history: Received 16 May 2014 Accepted 25 March 2015 Available online 15 April 2015 JEL classification: G31 E52 Keywords: Monetary policy Transmission channels Asymmetric effect Corporate investment Dynamic adjustment ABSTRACT We investigate monetary policy effects on corporate investment adjustment, using a sample of China’s A-share listed firms (2005–2012), under an asymmetic framework and from a monetary policy transmission channel perspective. We find that corporate investment adjustment is faster in expansionary than contractionary monetary policy periods. Monetary policy has a significant effect on adjustment speed through monetary and credit channels. An increase in the growth rate of money supply or credit accelerates adjustment. Both effects are significantly greater during tightening than expansionary periods. The monetary channel has significant asymmetry, whereas the credit channel has none. Leverage moderates the relationship between monetary policy and adjustment, with a greater effect in expansionary periods. This study enriches the corporate investment behavior literature and can help governments develop and optimize macro-control policies. Ó2015 Sun Yat-sen University. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). 1. Introduction Investment decisions are one of the three main financial decisions made by corporations. Modigliani and Miller (1958) propose that corporate investment decisions are independent of financing decisions under a series of strict assumptions. Subsequently, researchers have relaxed the strict hypothesis of the Modigliani–Miller theorem and developed the theory of investment cash flow sensitivities, based on the perspective of financing constraints caused by asymmetric information, and the theory of free cash flow over-investment, based on the perspective of agency conflicts. These theories argue that the appearance of imperfect markets and agency http://dx.doi.org/10.1016/j.cjar.2015.03.001 1755-3091/Ó2015 Sun Yat-sen University. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). ⇑ Corresponding author. E-mail addresses: [email protected] (Q. Fu), [email protected] (X. Liu). China Journal of Accounting Research 8 (2015) 91–109 HOSTED BY Contents lists available at ScienceDirect China Journal of Accounting Research journal homepage: www.elsevier.com/locate/cjar conflicts affects the scale and cost of enterprise financing, thereby affecting the decisions and efficiency of corporate investment. The macroeconomic policy environment affects corporate investment decisions. Management science research has recently focused on overcoming the micro–macro divide in the field, expanding research methods and theoretical innovation and bridging the science-practice gap (Aguinis et al., 2011). Studies on the decisionmaking behavior of micro-enterprises that consider macro policies are increasingly common (Fan et al., 2014; Jiang and Rao, 2011; Rao et al., 2013). Studies based on the monetary policy perspective mainly focus on the influence of monetary policy on capital structure dynamic adjustment (Cook and Tang, 2010; Luo and Nie, 2012; Ma and Hu, 2012; Su and Zeng, 2009), the policy of cash holdings (Baum et al., 2006, 2008; Zhu and Lu, 2009) and credit financing (Li and Wang, 2011; Rao and Jiang, 2013a,b). Few studies focus on investment decisions. Monetary policy is an important macro external variable that affects the investment decisions of enterprises. There is a body of literature focusing on the effect of monetary policy on corporate investment. Jing et al. (2012) find that loose monetary policy reduces the financing constraints of private enterprises. However, the financing redundancy resulting from loose monetary policy leads to inefficient investments by private enterprises with poor or general investment opportunities. In contrast, a good financing environment enables a company to take advantage of more investment opportunities, enhancing the efficiency of capital allocation when the company faces better investment opportunities. Xuan (2012) finds that a company can improve its ability to obtain loans and its investment level during tight monetary policies if it follows an ongoing conservative debt financial policy during expansionary monetary policies. Companies that follow a conservative debt financial policy are able to respond to monetary policy shocks and weaken their effects. Liu et al. (2013) find that internal capital markets in business groups buffer the effect of monetary policy on corporate investment. The studies on monetary policy and corporate investment behavior mainly focus on under- and overinvestment caused by credit financing constraints. Few studies explore the influence of monetary policies and transmission channels on the direction and speed of investment dynamic adjustment, especially from an asymmetric perspective. By clarifying these issues, we can reveal monetary policy transmission mechanisms at the micro level and examine their effects. Therefore, this paper uses Richardson’s (2006) estimation model of expected investment and Flannery and Rangan’s (2006) partial adjustment model to study the influence of monetary policy states and transmission channels on the direction and speed of investment dynamic adjustment. Our results indicate that corporate investment adjustment is faster during expansionary monetary policy periods than contraction periods. The effect of the money supply on the corporate investment adjustment speed is significantly greater in tight monetary policy periods than in loose periods. This effect is significantly asymmetric. An increase in the growth rate of the credit scale accelerates corporate investment adjustment. This channel does not have a significant asymmetric effect. Leverage has a greater effect on corporate investment in expansionary monetary policy periods. The contribution of this paper is as follows. First, the estimation model of the dynamic adjustment of corporate investment is designed by integrating the investment efficiency and partial adjustment models. This model provides the basis for studying the effect of monetary policy on the dynamic adjustment of corporate investment. Second, we study the effect of monetary policy transmission channels on corporate investment behavior through detailed microscopic transmission channels of monetary policy. Third, we examine whether monetary policy and its transmission channels have an asymmetric effect on the adjustment of corporate investment. Finally, the literature mainly focuses on the influence of financing constraints on investment, due to the credit channel of monetary policy. We simultaneously pay attention to the effect of the monetary channels of monetary policy on investment opportunities. This study provides valuable policy implications for monetary authorities and managers. First, policymakers should consider the effects of different policy instruments. Money supply and credit policy are effective tools for influencing corporate investment adjustment during contractionary monetary policy. Interest rates are an effective tool during expansionary monetary policy. Leverage has a greater effect on corporate financing ability during expansionary monetary policy than contractionary monetary policy. Monetary authorities 92 Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 should pay more attention to firms with high leverage during loose monetary policies to detect financing difficulties. Second, policy-makers should focus on optimizing the corporate investment scale and improving corporate investment efficiency to avoid over-investment and the resulting overcapacity. Company decision-makers need to pre-judge the influence of different policy instruments implemented by monetary authorities on corporate finance and investment opportunities. They should adopt an effective response in advance to ensure that the level of corporate investment can maximize returns. The rest of the paper is organized as follows. In Section 2, we provide an overview of the macro policies in the institutional background of China and refine the research questions. Section 3presents the model design, key concepts and definitions. Section 4shows the sample selection and data sources. In Section 5, the empirical results are reported and robustness tests are conducted. Section 6presents the discussion and Section 7sum- marizes the main conclusions. 2. Institutional background analysis and research question refinement Before 1978, a single planned economic system was implemented in China. The government relied on administration and planning to manage the economy, to poor effect and economic fluctuation. After the reform and opening up, especially in the mid-1980s, a market-oriented reform model was established. The Chinese economic environment and conditions were changing. In 1993, the Communist Party of China clearly proclaimed that establishing a socialist market economic system was the goal of its economic reform at its fourteenth conference. Since then, China has begun to gradually transform from a planned economy to a market economy. The government has gradually shifted its macroeconomic management from relying mainly on planning and executive orders to using market-based instruments, such as fiscal and monetary policies, in accordance with the market-oriented reform. The main objective of macroeconomic regulation and control is the pursuit of stable economic growth with a reasonable level of the Consumer Price Index (CPI). The government’s macroeconomic control focuses on adjusting the aggregate equilibrium with short-term, counter-cyclical, discretionary characteristics. Since 1997, economic growth has been steady and the CPI has fluctuated in a reasonable interval, as shown in Fig. 1. This shows enhanced macro-control ability and the effectiveness of market-based measures. As can be seen from the M 1 (a narrow measure of the money supply including currency and demand deposit) and credit scale growth rates, the discretionary monetary policy mainly uses counter-cyclical measures to achieve steady economic growth with a reasonable level of CPI. China used to mainly use quantity-oriented monetary policy tools such as adjusting the statutory deposit reserve ratio, open market operations and credit scale control. Price-based monetary policy tools based on interest rates were used at a lower frequency. On 19 July 2013, approved by the State Council, the People’s Bank of China decided to stop controlling the lending rates offered by financial institutions, which was an important step in market-based interest rate reform. 1 Under this reform, economic stimulus policies are no longer able to depend on liquidity injections. The price adjustment mechanism in the market of credit supply and demand is now active. This mechanism can optimize the allocation of credit resources and will have a profound effect on monetary policy transmission channels, mechanisms and effects. How do macroeconomic policies affect a real economy? Do macro policies play their expected role? What are their transmission mechanisms? To answer these questions, we need to analyze and test the mechanisms and policy effects of macroeconomic policies at the micro level. Previous studies mainly focus on monetary policies’ transmission channels, mechanisms and consequences from a macro perspective. We analyze the microscopic effect of monetary policy transmission channels on corporate investment behavior. 1 Approved by the State Council, the People’s Bank of China decided to remove controls on the lending interest rates offered by financial institutions to their clients from 20 July 2013. The loan interest rates of financial institutions are now determined autonomously by the financial institutions according to business principles. On 11 March 2014, Zhou Xiaochuan, the central bank governor, stated at a Chinese People’s Political Consultative Conference that “deposit interest rate liberalization is certainly in the plan and probably can be realized within one or two years.” Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 93 2.1. Asymmetric effects of monetary policy on corporate investment For decades, macroeconomists have debated whether monetary policy has the same effect on real output during economic recessions and expansions. Before the 1920s, most economists believed that contractionary and expansionary monetary policies had symmetric effects, suggesting a linear relationship between money supply and output. After the 1920s, economists gradually realized that a “tightening monetary policy can effectively restrain [an] overheated economy, but the effect of [a] loose monetary policy in promoting economic growth is not obvious, which implies the effect of monetary policy is asymmetric.”In the 1930s, Keynes argued with Pigou over whether monetary policies had less or no effect on output during a severe economic downturn. The limited effectiveness of an expansionary monetary policy was partially explained when the concept of a “liquidity trap”was introduced. In a liquidity trap, interest rates are so low that people believe that they cannot drop further. The monetary policy then fails (Keynes, 1936). At the beginning of the 1990s, studies that empirically test the asymmetric effects of monetary policy gradually began appearing. Cover (1992) examines quarterly US post-war data from 1951 to 1987 and concludes that positive money supply shocks have no effect on output, whereas negative shocks reduce output. Karras (1996) examines 18 European countries from the 1953–1990 period and finds that negative money supply shocks have a statistically significant effect on output, whereas positive shocks have a statistically insignificant effect. Karras and Stokes (1999) find that the effects of money supply on prices and output of private consumption are symmetric, whereas the response of fixed investment is characterized by asymmetries, very similar to those that affect output. The evidence from China for asymmetrical monetary shock effects is mixed. Huang and Deng (2000) use Chinese quarterly data from 1980 to 1997 and find the effects of monetary policies to be very different between China and Western countries. They find that the M 1 money supply shock has symmetric effects, whereas the M 2 (a broad measure of the money supply including currency, demand deposit and savings deposits) money supply shock has asymmetric effects. This asymmetry is opposite to that in Western countries: a positive money supply shock significantly affects output, whereas a negative money supply shock does not. However, Liu (2002) examines China’s monthly data from 1990 to 2001 and suggests that the decelerating effect of a tight monetary policy is greater than the accelerating effect of an expansionary monetary policy. Chen et al. (2003) and Chen (2006) reach a similar conclusion to Liu after examining China’s quarterly data from 1993–2002 and 1993–2005, respectively. Thus, due to differences in methods and sample windows, studies on the asymmetry of monetary policy effects at the macro-level do not reach consistent conclusions. Does monetary policy have an asymmetrical effect on enterprise at the micro-level? Based on enterprise micro data, Gong and Meng (2012), Jing et al. (2012) and Qian (2013) find that expansionary and contractionary monetary policies have asymmetrical effects on corporate investment. However, the asymmetry is opposite to that found at the macro-level: expansionary monetary policy significantly alleviates financial constraints and promotes corporate investment, whereas contractionary monetary policy does not significantly Figure 1. GDP growth, CPI growth and monetary policy from 1978 to 2012. 94 Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 reduce corporate investment. The investment scale is sticky when adjusting downward due to investment inertia and sustainability. The transmission of monetary policy also has a lag effect, between a policy’s implementation and managers in investment decision-making perceiving the implications of the policy. Our first concern is therefore how different types of monetary policies affect the adjustment of corporate investment and whether expansionary and contractionary monetary policies have asymmetric effects on corporate investment. 2.2. Monetary policy transmission channels and the dynamic adjustment of investment in micro enterprises Macroeconomic monetary policies have many relatively clear microscopic transmission channels, such as the money channel (which includes interest rates, exchange rates and the asset prices approach) and general credit channel of transmission (Bernanke and Blinder, 1992; Bernanke and Gertler, 1995). According to neoclassical economics, monetary policymakers use their leverage over short-term interest rates to influence the cost of capital and, consequently, spending on durable goods, such as fixed investment, housing, inventories and consumer durables. In turn, changes in aggregate demand affect the level of corporate investment. When the central bank raises interest rates, there is a corresponding increase in the cost of debt financing and the external financing constraints of companies (Luo and Nie, 2012). Companies become more dependent on internal financing or reduce current investment to dynamically adjust their scale of investment. Since 1990, monetary economists, such as Benanke, Gertler, Kashyap and Stein, have proposed the theory of credit transmission of monetary policy when they study the role of micro-level enterprises in the monetary policy transmission process. Credit transmission theory suggests that monetary policy affects the availability of financing mainly through increasing or decreasing the supply of bank loans, thereby affecting the supply of corporate investment (Bernanke and Gertler, 1995; Oliner and Rudebusch, 1996). The credit rationing policy, which is used as an important monetary policy instrument in China 2 , imposes a total credit limit. The total amount of new loans issued by all commercial banks every year cannot exceed the annual credit stipulated by the People’s Bank of China in principle (Su and Zeng, 2009). Through the bank lending channel, a tight monetary policy reduces bank reserves and forces banks to shrink their loans, which reduces the commercial bank loans available to enterprises (Kashyap et al., 1993). In addition, due to economic structural adjustments, transformation and upgrading, banks are encouraged to issue loans to enterprises in the advanced manufacturing and strategic emerging industries. In contrast, loans to high energy consumption, high emission industries and overcapacity industries are strictly controlled, which strengthens bank credit financing constraints for some enterprises. Researchers are interested in the effect of monetary policies on corporate investment behavior through the different transmission channels. Bernanke and Gertler (1995) note that monetary policy has a significant effect on long-term investment and find that monetary policy influences corporate investment through both the interest rate channel and the level of financing constraints. Chatelain and Tiomo (2003) suggest that monetary policy influences corporate investment through the interest rate channel, which can adjust the cost of capital, and through the credit channel, which can adjust external financing constraints. Zulkhibri (2013) finds that monetary policy significantly affects firms’ access to external finance when interest rates are increasing. Bank-dependent firms are the most vulnerable to this effect. Internal finance is more important for high leverage firms during tight liquidity conditions. Studies on Chinese companies draw similar conclusions. Zhang et al. (2012) study the dual effects of monetary policy on corporate investment supply and demand. They find that changes in monetary policy change investment opportunities, affect a company’s willingness to invest through monetary channels, change the company’s ability to raise funds and the supply of investment funds through the credit channel and ultimately affect the company’s investment decisions. Monetary policies also affect corporate investment in companies with different financing constraints through different transmission channels. The monetary channel has a larger effect on low financing constraints companies, whereas the credit channel has a larger effect on high 2 On 1 January 1998, the People’s Bank of China abolished the control of the size of loans by state-owned commercial banks, which had been practiced for nearly five decades. At the end of 2007, to effectively control the high inflation rate, the central bank enabled credit size control again. Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 95 financing constraints companies. Huang et al. (2012) find that quantity-oriented and price-based monetary policies have heterogeneous effects on corporate investment behavior. The influence of monetary policies is constrained by the liquidity, inventory, size and asset–liability ratio of a firm. Firms with higher liquidity, lower inventory levels and lower asset–liability ratios are less sensitive to the effects of the two kinds of monetary policies. The larger a firm is, the less it is affected by quantity-oriented monetary policies, but the more sensitive it is to price-based monetary policies. Fig. 2 presents the transmission channels and mechanisms by which monetary policy influences corporate investment behavior. When monetary policy changes (for example, from easing to tightening), it affects corporate investment opportunities and external financing constraints through the credit and monetary channels, respectively. Rational decision-makers in enterprises therefore actively consider adjusting their investment plans and scale to respond to these changes. From the perspective of credit financing constraints caused by the credit transmission channel, during a monetary policy contraction, corporate credit financing constraints and the opportunity cost of investment increase as the credit supply decreases. According to the net present value (NPV) rule and the theory of maximizing profit, the enterprise will reduce its investment projects to adjust its investment scale. During a loose monetary policy, external financing constraints and the cost of capital decline as the credit supply increases. According to the NPV rule, many projects with original negative NPV become profitable, so enterprises will expand their scale of investment to maximize profit. From the perspective of the monetary transmission channel, during expansionary monetary policy, the total market demand increases as the base money supply increases. Enterprises expand production and increase their scale of investment due to the increase in investment opportunities. During tight monetary policy, the total market demand decreases and the cost of capital rises as the money supply decreases. Companies reduce their scale of investment as the reduction in investment opportunities causes investment demand to decrease. Is there a linear relationship between the changes in monetary policy and corporate investment? Is there an asymmetric effect? Do different monetary policy transmission channels and tools have the same effect on the adjustment speed of corporate investment? All of these questions require in-depth empirical research. Leverage plays an important moderating role in the effect of monetary policy on corporate investment. Lang et al. (1996) show that the effect of monetary policy changes on firms with high levels of leverage is larger than on those with low levels of leverage. There is a negative relationship between leverage and future growth at the firm level. Hu (1999) finds that monetary contractions reduce the growth of investment more in highly leveraged firms than in less leveraged firms. The results suggest that a broad credit channel for monetary policy exists and that it can operate through leverage, as adverse monetary shocks aggravate real debt burdens and raise the effective costs of investment. Based on the above analysis, we empirically examine the effects of different monetary policy channels on the speed of corporate investment adjustment and whether there is an asymmetric effect. We test the role of leverage in the effect of monetary policy on corporate investment. Monetary policy transmission mechanisms Monetary channel Credit channel Lending and deposit interest rates, deposit reserve ratio, rediscount rate and open market operations Total credit limit Credit rationing policy Impact on Impact on Supply of M1 and M2 and Total market demand Scale and structure of total credit Corporate investment opportunities and demand Corporate financing constraints and investment supply Figure 2. The transmission channels and mechanisms of monetary policy and its influence on investment behavior. 96 Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 3. Model design and definition of key concepts 3.1. Dynamic adjustment model of corporate investment We design the dynamic adjustment model of corporate investment with the effect of monetary policy by integrating Richardson’s (2006) investment efficiency model and Flannery and Rangan’s (2006) partial adjustment model. The model is derived as follows. Step 1: Estimated model of expected investment. According to Richardson (2006), there is an optimal scale of corporate investment. It depends on the last operating conditions of a company in a given external environment. We set the estimated model of expected corporate investment as follows: I i;t¼aXi;t1;ð1Þ where I i;trepresents the expected investment of company iin year tand Xi;t1is a vector of firm characteristic variables that affect the expected investment. Step 2: Standard partial adjustment model. In a frictionless world, firms quickly move back to their target level, which is the level they choose in the absence of any adjustment costs. However, in the presence of adjustment costs, firms may partially adjust back to their expected level of investment over multiple periods. We use Flannery and Rangan’s (2006) standard partial adjustment model to estimate the speed of the adjustment of corporate investment to the next period target level. The standard partial adjustment model of corporate investment is as follows: Ii;tIi;t1¼kðI i;tIi;t1Þþ/i;t;ð2Þ where Ii;tand Ii;t1represent the actual investment level for firm iin periods tand t1 and krepresents the adjustment speed of corporate investment to the target level from period t1 to period t. The larger the value of k, the faster the adjustment speed. k= 1 indicates that firms fully adjust for any deviation away from their target investment level. We expect kto be less than 1 in the presence of adjustment costs. Step 3: Integrated partial adjustment model. Following Flannery and Rangan, we substitute (1) into (2) and rearrange. The model of integrated corporate investment partial adjustment model is: Ii;t¼ð1kÞIi;t1þðkaÞXi;t1þxi;t:ð3Þ Step 4: Dynamic adjustment model of investment with monetary policy effects. Relaxing the assumption of a fixed external economic policy, we argue that a manager develops investment plans at the beginning of each year according to the operating conditions in the previous year and dynamically adjusts them according to this year’s changes in macroeconomic policies. To investigate the effects of monetary policy and its transmission channels on the adjustment speed of corporate investment, we develop an extended integrated partial adjustment model. We add the interaction term between the variables for the current monetary policy period and the lagged variable of investment (MCtIi;t1) in the right of model (3), as follows: Ii;t¼ð1kÞIi;t1þgMCtIi;t1þðkaÞXi;t1þxi;t;ð4Þ where MCtrepresents monetary policy variables, proxied by the M 1 and M 2 growth rates and loan interest rates in the monetary channel and credit growth rates in the credit channel. The adjustment speed of corporate investment becomes k0¼kgMCt.AsMCtis generally positive, when the coefficient on the interaction item is significantly negative, the adjustment speed of corporate investment increases with an increase in the monetary policy variables, and vice versa. The calculations and definitions of the variables are shown in Table 1. Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 97 3.2. Definition and determinants of corporate investment According to Richardson’s (2006) definition, total investment expenditure can then be split into (i) required investment expenditure to maintain assets in place and (ii) investment expenditure on new projects. We define corporate investment as new investment with a proxy using cash expenditure for buying fixed assets, intangible assets and other long-term assets and standardizing with total assets to eliminate the influence of size differences. Following Richardson (2006), we estimate expected investment according to the following regression specification: Ii;t¼b0þb1Growthi;t1þb2Levi;t1þb3Cashi;t1þb4Listagei;t1þb5Lnsizei;t1þb6Returni;t1 þb7Ii;t1þXIndustry þXYear þei;t:ð5Þ The determinants of investment decisions include measures of growth opportunities, leverage, the level of cash, firm age, firm size, past stock returns, prior level of firm investment, industry fixed effects and annual fixed effects. 3.3. Definition of monetary policy states and transmission channels 3.3.1. Definition of monetary policy states The government often describes three monetary policy states: active or expansionary monetary policy, prudent monetary policy and tight monetary policy. However, monetary policy is often divided into tightening and expansionary monetary policies, based on different indicators in the academic literature. Table 1 Variable definitions. Variable Name Definition and calculation Dependent variables I t Investment Cash for buying fixed assets, intangible assets and other long-term assets/total assets Isd t Change rate of investment (I t I t1 )/I t1 Variables of interest MP Monetary policy states MP equals 1 if in a tight monetary policy period, and 0 otherwise M 1 Annual growth rate of M 1 (Money supply M 1 in this year – Money supply M 1 in the previous year)/Money supply M 1 in the previous year M 2 Annual growth rate of M 2 (Money supply M 2 in this year – Money supply M 2 in the previous year)/Money supply M 2 in the previous year Credit Credit growth rate Growth rate of annual cumulative new RMB loans issued by financial institutions RLoan interest rates Weighted average interest rate of medium- and long-term loans with maturities in the 1–3 year range. If the benchmark interest rate is adjusted several times within a year, the annual weighted lending rate is calculated by the monthly weighted average of each benchmark interest rate in a year Control variables Lnsize Asset scale Natural logarithm of total assets Growth Growth potential Growth rate of operating income Cash Cash holdings (Cash + short-term investments or tradable financial assets)/total assets Lev Leverage level Total liabilities/total assets Return Market return Cumulative return rate from May in year tto April in year t+1 Listage Number of years listed The number of years between the annual financial report and the firm’s IPO Industry Industry Industry dummies, which equal 1 if the observation belongs to each particular industry, and 0 otherwise Year Year dummies, which equal 1 if the observation belongs to a particular year, and 0 otherwise 98 Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 5.2.5. Robustness tests We test the robustness of our results on the asymmetric effect in the monetary channel by repeating the test process using the M 2 growth rate and lending interest rates as proxies for the monetary channel of monetary policy. The results of the two tests, shown in Table 10, indicate that the differences in the coefficient estimates of the interaction term are significant at the 5% level. The results are therefore robust. The results show that the coefficient of It1is 0.598 and the coefficient of M2It1is 0.490 when we use the M 2 growth rate as the proxy variable of the monetary channel. The adjustment speed is then k0¼0:402 þ0:49 M2. In our sample interval, a typical firm closes about 46.87% of the gap between the actual and target investment levels in 2011, which has the lowest M 2 growth rate of 13.61%, corresponding to an adjustment HALF-LIFE of 1.48 years. In contrast, it corrects about 53.76% of the gap between the actual and target levels in 2009, which has the highest M 2 growth rate of 27.68%, corresponding to an adjustment HALF-LIFE of 1.29 years. The results show that expanding monetary policy to increase the growth rate of M 2 can speed up the adjustment of corporate investment. The effect of the change in M 2 supply on the adjustment speed of corporate investment is significantly greater in tight monetary policy periods than in loose monetary policy periods. The results show that the coefficient of It1is 0.375 and the coefficient of RIt1is 2.191 when we use lending rates as the proxy variable of the monetary channel. The adjustment speed is then k0¼0:625 2:191 R. In our sample interval, a typical firm closes about 50.67% of the gap between the actual and target investment levels in 2009, which has the lowest lending rates of 5.40%, corresponding to an adjustment HALF-LIFE of 1.37 years. In contrast, it corrects about 46.57% of the gap between the actual and target levels in 2008, which has the highest lending rates of 7.27%, corresponding to an adjustment HALF-LIFE of 1.49 years. The results show that contracting monetary policy by raising lending rates can slow down the adjustment of corporate investment. The effect of the change in lending rates on the adjustment speed of corporate investment is non-significantly greater in loose monetary policy periods than in tight monetary policy periods. Table 10 Robustness test results. I t Full sample Expansion (MP = 0) Contraction (MP = 1) Empirical p-value I t1 0.598 *** 0.561 *** 0.923 *** 0.2160 (23.15) (17.86) (9.30) M 2 *I t1 0.490 *** 0.285 * 2.474 *** 0.0240 ** (3.62) (1.91) (4.12) Constant 0.0258 *** 0.00168 0.0521 *** (2.82) (0.14) (3.78) Xand Industry Yes Yes Yes Wald chi 2 6238.61 3300.60 3021.29 R-square 0.4034 0.4178 0.3965 N 9256 4628 4628 I t1 0.375 *** 0.333 *** 0.371 *** 0.3730 (6.31) (2.78) (2.83) R*I t1 2.191 ** 3.001 2.208 0.0030 *** (2.30) (1.45) (1.12) Constant 0.0262 *** 0.00261 0.0593 *** (2.86) (0.21) (4.32) Xand Industry Yes Yes Yes Wald chi 2 6225.49 3297.94 2995.27 R-square 0.4029 0.4176 0.3944 N9256 4628 4628 Note: (1) tstatistics in parentheses: * p<0.10, ** p<0.05, *** p<0.01. (2) Empirical p-values are generated using 1000 bootstrapping simulations to test the differences between the coefficient estimates of MC It1. (3) We control for the related variables (X) and industry, but do not report them as there are too many variables. Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 105 6. Further discussion 6.1. Monetary policy and dynamic adjustment of corporate investment: role of leverage The literature shows that the leverage level plays an important moderating role in the effect of monetary policy on the adjustment of corporate investment. We examine the effect of the leverage level on the relationship between the adjustment of corporate investment and monetary policy in different states. The results are shown in Table 11. The results show that the coefficient of It1is 0.323 and the coefficient of Lev It1is 0.349. According to the economic significance of the model, the adjustment speed is k0¼0:677 0:349 Lev. A typical firm in our sample closes about 64.13% of the gap between the actual and target investment levels in one year when leverage is at its lowest level of 10.219%, corresponding to an adjustment HALF-LIFE of 1.08 years. In contrast, it corrects about 39.96% of the gap between the actual and target levels when leverage is at its highest level of 79.486%, corresponding to an adjustment HALF-LIFE of 1.73 years. The results show that the higher the leverage, the slower the adjustment speed of corporate investment. This result is due to the financing constraints that reduce the external financing supply for corporate investment. Leverage has a greater effect on the adjustment speed of corporate investment in loose monetary policy periods than in tight monetary policy periods. The observed differences in the coefficient estimates indicate that there is an asymmetric effect at the 10% significance level. The implication for policy-makers is that monetary authorities should pay more attention to firms with high leverage during loose monetary policy periods to solve their financing difficulties. 6.2. Differences between the relative and absolute speed of corporate investment adjustment The empirical investigation above reports the effect of monetary policy on the relative speed of adjustment to the optimal level of investment. However, the effect of monetary policy on the absolute speed of adjustment of corporate investment is a more intuitive measure, which is the rate of change in the level of investment from one year to another. We repeat the empirical estimates using the absolute adjustment speed and compare the results. The empirical results of model (6) are shown in Table 12. Isdt¼ðIi;tIi;t1Þ=Ii;t1¼aMCtþbXi;t1þdi;t:ð6Þ The results show that the effects of monetary policy variables on the absolute speed of adjustment of corporate investment are not significant, except for the effects of M 1 and lending rates R in tight monetary policy periods. However, lending rates have a greater effect on the absolute adjustment speed of corporate investment in tight monetary policy periods than in loose monetary policy periods, which is inconsistent with the results Table 11 Estimating the effect of leverage on the adjustment speed of corporate investment. I t Full sample Expansion (MP = 0) Contraction (MP = 1) Empirical p-value I t1 0.323 *** 0.315 *** 0.335 *** 0.3820 (13.93) (9.83) (9.99) Lev *I t1 0.349 *** 0.349 *** 0.344 *** 0.0640 * (8.66) (6.36) (5.82) Constant 0.0142 0.0120 0.0466 *** (1.54) (0.97) (3.37) Xand Industry Yes Yes Yes Wald chi 2 6342.13 3363.81 3049.19 R-square 0.4074 0.4224 0.3987 N9256 4628 4628 Note: (1) tstatistics in parentheses: * p<0.10, ** p<0.05, *** p<0.01. (2) Empirical p-values are generated using 1000 bootstrapping simulations to test the differences between the coefficient estimates of MC It1. (3) We control for the related variables (X) and industry, but do not report them as there are too many variables. 106 Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 found using the relative speed of adjustment. All of the empirical p-values are larger than 10%, indicating no asymmetric effects on the absolute speed of adjustment of corporate investment under different monetary policy states. The differences in the estimation results using relative and absolute adjustment speeds of corporate investment may be caused by the measure perspective of the two kinds of speed. The relative speed of adjustment adjusts to the optimal investment level, which takes into account the effects of over- or under-investment. The absolute speed of adjustment is based only on the rate of change in corporate investment. Therefore, we argue that the relative speed of adjustment is suitable for choosing monetary policy to optimize the investment scale. For example, in response to the international financial crisis of 2007, the Chinese government implemented an expansionary monetary policy and proactive fiscal policy with a 4 trillion investment plan from 2008. Although these measures played a short-term role in economic recovery, over-investment has resulted in overcapacity and redundant construction, which is harmful to the long-term development of the economy. 7. Conclusions and implications Based on China’s A-share listed firms from 2005 to 2012, we investigate the effects of monetary policy on the direction and speed of corporate investment adjustment. The results show that the adjustment speed of corporate investment is faster in expansionary monetary policy periods than in contractionary monetary policy periods. The monetary channel, proxied by M 1 ,M 2 and loan interest rates, has a significant effect on the adjustment of corporate investment. This effect is asymmetric across different monetary policy states. The credit channel, proxied by credit scale, has a significant, but not asymmetric effect on the adjustment of corporate investment. Leverage is an important factor for restricting the adjustment of corporate investment. The higher the leverage, the slower the adjustment speed of corporate investment. Monetary authorities should pay attention to the effect of monetary policy on the adjustment of corporate investment. Expansionary monetary policy more effectively adjusts corporate investment than tightening policy. A change in the growth rate of M 1 or M 2 has a significantly greater effect on the adjustment of corporate investment during tight monetary policies. Leverage has a greater effect on financing capacity in loose monetary policy periods than in tight periods. Monetary authorities should pay more attention to firms with high leverage during loose monetary policy periods. Acknowledgements We acknowledge the helpful comments and suggestions provided by Professor George YONG YANG from the Chinese University of Hong Kong, the anonymous reviewers and the participants of the Summer Table 12 Estimating the effect of monetary policy on the absolute speed of adjustment of corporate investment. Isd t Full sample Expansion (MP = 0) Contraction (MP = 1) Empirical p-value M 1 0.293 0.150 1.570 * 0.4410 (0.71) (0.31) (1.66) M 2 0.304 0.446 0.583 0.4780 (0.37) (0.47) (0.15) R4.877 2.012 25.44 * 0.4670 (0.82) (0.15) (1.65) Credit 0.00198 0.0763 0.386 0.4470 (0.03) (0.86) (1.32) Lev t1 0.103 0.751 ** 0.541 * 0.4830 (0.48) (2.46) (1.80) Note: (1) tstatistics in parentheses: * p<0.10, ** p<0.05, *** p<0.01. (2) Empirical p-values are generated using 1000 bootstrapping simulations to test the differences between the coefficient estimates of MC It1. (3) We control for the related variables and industry, but do not report them because there are too many variables. Q. Fu, X. Liu / China Journal of Accounting Research 8 (2015) 91–109 107 Research Workshop of the China Journal of Accounting Research in July 2014. We are completely responsible for the content of this paper. 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