Capital Misallocation, Asset Specificity and Firm Value: Based on the reclassification of business activities

Transcription

1 Capital Misallocation, Asset Specificity and Firm Value: Based on the reclassification of business activities WANG Zhu-quan, DUAN Bing-lei, WANG Yuan-zhuo, CHEN Guan-lin 1 (Management College of Ocean University of China, Qingdao , China) Abstract: Under the New Normal in China, improving the allocation efficiency of capital and other factors is an important way to realize the transformation of economic growth mode. This paper constructs the firm capital misallocation variable from the perspective of reclassification of business activities. Based on the empirical analysis of the Chinese A-share listed companies from 2006 to 2015, it is found that the misallocation between the business activities is common in China and the firms with the more serious capital misallocation have lower firm values (ROA and Tobin s Q). Further analysis shows that the increase of asset specificity will aggravate the negative effect of capital misallocation on ROA, but will mitigate the negative effect of capital misallocation on Tobin s Q. This paper discovers a kind of capital misallocation that damages firm value, broadens the research angle of micro-capital allocation, and provides reference and suggestion for the capital allocation of listed companies. Key Words: capital misallocation; business activities; asset specificity; firm value I. Introduction In the modern economy, capital allocation is the core of resource allocation. In accordance with the capital allocation process, the capital allocation can be divided into two links that social capital allocates capital to firms with a variety of different organizational forms through the market, and then the firms allocate capital to various branches, subsidiaries or various projects (Lu Jianxin, 2008).China's resource allocation efficiency in the macro level and micro level is relatively low (Yang Mianzhi, 2007).The study of micro-capital allocation plays an important role in understanding the operation of Chinese firms' capital, further standardizing the capital operation of firms and 1 Contact information: zhuquanw@126.com; @163.com; yuanzhuowang@163.com; cgldesign@126.com.

2 improving the sustainable profitability of Chinese firms. However, the existing literatures on micro-capital allocation focus on the capital allocation efficiency between firms, various subsidiaries of the diversified firms or the various branches of firms makes it fail to further open the firms black box and study the capital allocation within the projects in-depth (Yang Mianzhi, 2007). With the development of China's market economy, the operation modes of firms become more and more diversified. Capital operation has become an important way in the operation of firms. Investment activities and operating activities have become more and more equal in value creation activities of firms. Domestic and foreign organizations, scholars have done a new exposition on the concept of business activities that are activities aimed at creating values, including operating activities and investment activities (IASB and FASB, 2008; Wang Zhu-quan, 2013).From the process of capital allocation, no matter how the capital is allocated to each branch or subsidiary, capital must be configured in the business activities in which the firm creates values. Therefore, whether the allocation of capital between business activities is efficient will play a significant impact on the firm value. However, due to the deep-rooted traditional business concept, there is little study on the problem of capital allocation from the perspective of business activities. This paper attempts to explore this problem by constructing the misallocation standard between business activities. The asset specificity of the firm is a key determinant of the firm's capital structure (O. Willamson, 1988), which has a significant impact on the firm's market competition and business activities (Li Qingyuan, 2007). Because operating activities are influenced by the asset specificity greatly, it will bring "exit obstacles" for operating activities to a certain extent, thus the level of firm asset specificity is bound to the relationship between capital misallocation and firm value. Does the capital misallocation between business activities of firms exist in China? Does the capital misallocation between business activities has an impact on firm value? Does the asset specificity affect the relationship between capital misallocation and firm value? This paper intends to use the data disclosed by CSMAR database and the data of impairment of listed companies disclosed by the working capital management database

3 of Chinese listed companies developed by China Enterprise Working Capital Management Research Center, creatively construct the measure of capital misallocation between Chinese firms' business activities, and discuss the impact of capital misallocation on firm value, and tries to explain the impact of asset specificity on capital misallocation and firm value, in order to make contributions to improving the micro-capital allocation theory. Firstly, this paper constructs the capital misallocation standard based on the financial information disclosed in the balance sheet and income statement of China's listed companies and the "value increase method" (Rajan, Zingales, 2000) in the internal capital market measurement model and the reclassification of business activities(the Stock of Capital Misallocation,CMs),as a proxy variable of capital misallocation of the business activities, to verify certain existing phenomena of "capital misallocation" in Chinese listed firms; Secondly, by constructing an empirical model to test the impact of capital misallocation on firm value, and to test the effect of asset specificity on capital misallocation and firm value, with A-share listed companies in China from 2006 to 2015 as initial samples. The study found that the capital misallocation between the business activities can significantly damage the firm value, that is, the greater the degree of capital misallocation, the lower the firm accounting performance and the market performance; The increase of asset specificity will aggravate the negative effect of capital misallocation on accounting performance, the greater the asset specificity of the firm, the greater of the capital misallocation to the accounting performance will be; The increase of the level of asset specificity will mitigate the negative effect of capital misallocation on market performance, the greater the degree of capital misallocation, the less of the capital misallocation to market performance will be. The results of this study show that the capital misallocation between the listed companies in China is serious, which seriously damages the firm value, hinders the development of the real economy, and reduces the overall allocation efficiency of social capital. The main contributions of this paper are as follows: (1) This paper, in theory, can make up for the problem that the current financial statements are not clear about the disclosure of specific business activities, which will help firms to analyze the efficiency of investment activities and business activities, and conducive to alleviate the prevalent phenomenon of

4 light investment return and low capital use efficiency in China's capital market. (2) Based on the reclassification of business activities, the paper finds out the capital misallocation between business activities of Chinese listed companies is serious for the first time, puts forward the index of measuring the misallocation of capital and investigates the economic consequences of capital misallocation for the first time, and tests the negative impact of capital misallocation on firm value, enriching the micro-capital allocation research. (3) In the past, the research on asset specificity focused on capital structure and so on, and there were few studies on asset specificity for capital allocation. This paper expands the research perspective of asset specificity, and provides new theoretical ideas and empirical evidence for the impact of asset specificity on firm value. II. Theoretical analysis and hypothesis development 1. Capital misallocation In the theory of corporate financial management, the financial activities of corporate can be divided into operating activities, investment activities and financing activities. With the development of the market economy and the deepening of research, more and more domestic and foreign organizations and scholars abandon the concept of operating activities as business activities. They regard both operating activities and investment activities 1 as an important part of the business activities which are used by firms to create values(iasb and FASB, 2008; Wang Zhu-quan, 2013), and think the reports of financial situation of enterprises in accordance with business activities (Which are listed are operating activities, investment activities) and financing activities will improve the efficient of financial statements on decision-makings (Ge Jia-shu, 2009), to meet the needs of rational investors for investment and decision-making in the capital market (Liu Yu-ting, 2009). Operating activities, investment activities are two major business activities for firms to create values, how the internal capital of firms allocated is related to the use efficiency of firm capital. In general, firms should invest more capital into more effective 1 The investment activities in this paper refer to the financial investments for outside such as equity and bond, which are different from the fixed assets investment in the general literature.although the investment activity is to invest market outside the corporate, it also can be seen as a department responsible for investment, and different from thetraditional internal capital market only with capital allocation within the corporate, and the definition of capital allocation just provide a new way of thinking for researches combining internal capital market and external capital market.

5 value-creating activities. However, due to the deep-rooted traditional business concepts and lack of research on the capital misallocation of business activities, firms do not understand or misunderstand the evaluation methods of the efficiency of business activities. Therefore, the capital misallocation between business activities occurred from time to time in China s firms. In this regard, based on the internal capital market perspective, many scholars (Almeida and Wolfenzon, 2006; Lu Jianxin, 2006; Yang Mianzhi, 2007) put forward the current study neither combines the internal capital market and external capital market, nor study the capital allocation of each division deeply, and the research on internal capital allocation should go beyond the scope of subsidiaries and corporate segments, and will focus on investment operation of projects within the corporate. Further consideration is given to capital misallocations between business activities, first of all, in China, corporate management is not perfect, agency problem is more serious, and the corporate ownership concentration is generally high, managers often have the motivation and ability to sacrifice the interests of shareholders to maximize their own interests (Jensen and Meckling, 1976; Jensen, 1986; Shleifer and Vishny, 1989; Johnson et al., 2000; Liu Jianhua, 2015). As there are more cash inflow projects and scale financing advantages existing in firm-groups, there are more cash flow within the firm being free to be dominated, which will easily lead to excessive investment behavior of managers (Stein, 2001). The current allocation of capital in operating activities and investment activities relies mainly on the decision-making of management, especially managers. It is easy for managers to act on their own interests. The allocation of capital among business activities is not based on the efficiency evaluation of business activities, but for the managers to maximize their own interests, which will lead to capital misallocation. Secondly, Lamont and Polk (2002) found that the discounts of diversified companies will increase with the diversification of company's investment opportunities, that is to say, the difference of investment opportunities will lead to the invalid allocation of internal capital. As China's stock market is not perfect, with chasing the concept and short-term speculation for the transaction-oriented, leading to a number of listed companies keen on capital operation, investment opportunities are often derived from the outside hot industries, transforming

6 from value-creating enterprises to value-assessment investment management company focusing on diverse businesses with non-competitive advantages and basis, lack of the ability to convert exogenous investment opportunities into actual operating performance and the value of the firm, and not to accumulate and enhance real sustainable development and competitiveness of firms as a result of continued investment expansion, and the basis of competitiveness is weakening (Zhu Wuxiang et al., 2002). In this context, the allocation of capital between the business activities of firms will ignore the long-term strategy and objectives due to the behavior of blind pursuit of short-term and diversified investments, such blind investment behavior will lead to capital misallocation, seriously damage the firm value. In addition, the existing enterprise performance evaluation system is still regarding operating activities as business activities, in the evaluation of performance, there is often less attention to investment activities, lack of evaluation index on the efficiency of business activities, can t measure the efficiency of the return rate of business activities, resulting in the actual decision-making failure, with the formation of capital misallocation among business activities, damaging the firm value. Due to the fact that in the real corporate operation, when the corporate performance is not good, there will be some obstacles, such as buried costs caused by asset specificity, and costs from workers dismissed, careers changed for combination of production, which may make some corporate unable to be out of the original industry, so these obstacles constitute exit barriers (Lu Hua, 2000; Yang Tianyu et al., 2009). In the corporate business activities, the exit barriers for operating activities are significantly greater than that of investment activities, therefore, in the corporate of capital misallocation with higher efficiency on investment activities and low efficiency on operating activities, the degree of capital misallocation often depend on exit barriers of operating activities, in particular the degree of asset specificity of the assets engaged in operating activities. In this case, firms will passively form capital misallocations due to exit barriers. In addition, the state-owned enterprises also have strong policy barriers, and the study found that China's state-owned enterprises seem to lack the motivation and ability (Lu Hua, 2000) to withdraw spontaneously, mainly due to the diversified objectives of state-owned enterprises and China's economic system and other institutional factors, and policy barriers brought by

7 these institutional factors will lead to the capital misallocation of business activities. Similarly, when the efficiency of operating activities is high and efficiency of investment activities is low, the capital misallocation will also form due to the entry barriers caused by industry access, policies and regulations. This shows that the capital misallocation between business activities may results from behaviors led by subjective factors due to management self-interest, imperfect capital markets, and imperfect business performance evaluation indicators. It is also determined by entry barriers, exit barriers, or policy barriers of the industry which operating activities of the firm engage, which is a second-best choice for firms. Therefore, under the background of more serious agent problem, imperfect stock market and imperfect current performance evaluation system, there will be more capital misallocation among the business activities, and the scientific evaluation index will be put forward, which is of great significance to perfect the research of micro-capital allocation. 2. The construction of capital misallocation indicators based on the perspective of business activities The key to measuring the misallocation of capital based on the perspective of business activities is to define the scope, risks and returns of the two types of business activities. First of all, this paper uses the reclassification method of business activities proposed by Wang Zhu-quan (2013) to calculate the total capital return rate, the return rate of investment activities and the return rate of capital of operating activities. The calculation formula is shown in Table 1.

8 Operating activities Funds Return Return rate Table 1 Table of Definition of Funds and Returns for Business activities Total business activities Investment activities Operating Activities Total assets + (Provision for diminution in value of inventory + impairment of other receivables + impairment of prepayments + provision for impairment of accounts receivable) - (bills payable + accounts payable + advance receipts + employees' salaries payable + taxes payable + other payables + other current liabilities + transactional financial liabilities + estimated liabilities + deferred income tax liabilities + other non-current liabilities) = Income before tax+ Financial expenses + 1/3 * Investment income on associates and joint ventures - Exchange gains / losses Total Fund Return Total Fund Average Monetary assets 1 + tradable financial assets + available-for-sale financial assets + held-to-maturity investments + non-current assets due within one year + long-term equity investments + long-term debt investments + investment real estate - transactional financial liabilities Investment income + 1/3 * Investment income on associates and joint ventures Gains / losses from changes in fair value Return on Funds for Investment Activities Funds for Investment Activities Total funds - investment activities funds Income before tax + Financial expense - Investment income - Gains / losses from changes in fair value - Exchange gains / losses Return on operating activities The average value of operating activities funds 1 In this paper, monetary funds are regarded as a low-risk financial investment. In order to study the robustness of the results, the capital misallocation index, which is divided into money activities, is also regressed in the robustness test, and there is no significant difference in the regression results, because of the diversification of monetary funds' motives. 2 "Investment income + 1/3 * Investment income of associates" means that the investment income of the joint venture will be converted to pre-tax value. 3 Gains / losses from changes in fair value are the fair value gains minus the loss.

9 Second, this paper draws lessons from the "value increase method" (Rajan, Zingales, 2000), "cash flow sensitivity method" (Maksimovic, Phillips, 2002 and Shcoar, 2002) in the internal capital market measurement model. Using the above indicators, a proxy variable based on the capital misallocation of the business activities is calculated. The calculation formula is as follows. r i,t CMs = ( Risk i,t r j,t Risk j,t ) ( c i,t + c i,t 1 C t + C t 1 c j,t + c j,t 1 C t + C t 1 ) Among them, subscript i, j, respectively represent investment activities, operating activities r i,t, r j,t respectively represent the return rate on investment funds, and return rate on funds for operating activities, c i,t, c j,t, C t respectively represent final investment activities funds, operating activities funds, total funds at the end of t, c i,t 1, c j,t 1, C t 1 respectively represent initial investment activities funds, operating activities funds, the total funds at the early period of t. It is noteworthy that, in the actual capital allocation decisions, not only the return rate of investment activities and operating activities, but also the risk of business activities will be taken into account, only to measure the relationship between the return rate and funds of business activities, which will ignore the risks of operating activities and investment activities. Therefore, this paper will take risk factors into the capital misallocation indicators, with the relationship between return rate on unit risk and funds to measure the degree of corporate capital misallocation. Risk i,t, Risk j,t respectively represents investment activity risk, operating activity risk.. The risk of the two business activities is measured by the degree of fluctuation of the operating activities and investment activities based on the measurement methods of John et al. (2008), Acharya et al. (2011), Mishra et al. (2011) and Chan et al. (2013) on operational risk. The calculation formula for risk (profit fluctuation) of business activities is as follows: Risk x,t = F T T 1 T 1 (r x,t 1 T r x,t) T = 3,x = i or j t=1 t=1 ( ) 2

10 In addition, when r x,t is at x=i, it represents return rate on investment activities, at x=j, it represents return rate on operating activities. As shown in the formula, this paper uses the standard deviation of the rolling values of the return on business activities from year t-1 to year t + 1 (three years) to calculate the risk of each activity, for example, the risk of operating activities of a firm in 2010 is the standard deviation of return rate of business activities in , and the risk of investment activities of a firm in 2010 is the standard deviation of return rate of investment activities in In addition, since the operational risk calculated in this way does not obey the normal distribution, this paper calculates the cumulative distribution probability (i.e., F (X)) of the standard deviation of return rate of the business activities representing the risk of business activities, and the risk of business activities is measured by the cumulative probability distribution of standard deviation of return rate. In the capital misallocation formula,( r i,t Risk i,t rate of business activities per unit risk, ( c i,t +c i,t 1 C t +C t 1 r j,t Risk j,t ) is used to measure the return c j,t +c j,t 1 )is used to measure the C t +C t 1 status of the allocation of funds to business activities. When the ( r i,t negative, and ( c i,t +c i,t 1 C t +C t 1 Risk i,t r j,t Risk j,t ) is c j,t +c j,t 1 ) is positive, indicating that the return rate of C t +C t 1 investment activities per unit risk is less than that of operating activities, while enterprises invested more capital into the investment activities, this situation is called "too much funds to the investment activities " of capital misallocation; When the ( r i,t positive, and ( c i,t +c i,t 1 C t +C t 1 Risk i,t r j,t Risk j,t ) is c j,t +c j,t 1 ) is negative, indicating that the return rate of C t +C t 1 investment activities per unit risk is more than that of operating activities, while enterprises invested more capital into the business activities, this situation is called " too much funds to the operating activities " of capital misallocation. From the theoretical analysis, when the capital is allocated between the business activities, only by investing all of the capital into the activities with high return rate per unit risk can the capital allocation become an effective state. However, in the actual operation of firms, in order to avoid risks and other reasons, this situation is rare for firms. Therefore, whether or not the CMs indicators are positive, this paper believes that there are different

11 degrees of capital misallocation existing in firms, and the smaller CMs, the greater the degree of capital misallocation; However, when the indicator symbol is negative, it means that the firm put more capital into the activities with lower return rate per unit risk, and this paper calls it serious capital misallocation. Therefore, this paper makes the following interpretation of the indicators: When the CMs are negative, the return rate of unit risk and capital investment symbol is opposite, which is a serious capital misallocation of operating activities; When the CMs are positive, the two symbols are the same, so the capital misallocation of operating activities is not serious; the smaller the value of CMs, the more serious the capital misallocation between operating activities. 3. Capital misallocation and firm value China's resource allocation efficiency in the macro level and micro level is relatively low. Combining the researches of domestic and foreign experts and scholars (Williamson, 1975; Stein, 1997; Aghion, Tirole, 1997; Inderst, Laux, 2003; Zou Wei, Qian Xuesong, 2005; Lu Jianxin, 2008; Shao Jun, Liu Zhiyuan, 2007; Wang Fengjuan, Zou Cunliang, 2009) on the micro capital allocation and internal capital market, whether the capital allocation of internal capital market is effective will significantly enhance (damage) firm performance and firm value. From the perspective of the internal capital market, the capital allocation can be regarded as the allocation of capital in the groups which is composed of two segments: operating activities and investment activities. Whether the capital is invested into the more efficient department will have a greater impact on firm value. Firm value is affected by governance structure, ownership structure, property rights and other factors (Sun Yongxiang, Huang Zuhui, 1999; Xia Lijun, Fang Yijiang, 2005; Wang Hui, 2003), and accounting performance (ROA) is a reflection of the firm's current value, suitable for horizontal comparison between firms, market performance (Tobin s Q) can be seen as a discount to future earnings. When the degree of capital misallocation between the business activities increases, more capital is put into the business activities with low return rate per unit risk, resulting in this capital to bring relatively low earnings, and thus the firm's accounting performance will be reduced, and the market performance will be compromised. Compared with the firms with low degree of capital misallocation, the

12 capital allocation behavior of the firms with large capital misallocation is not in line with the goal of maximizing the interests of the firms and does not put the capital into the business activities which can produce more revenue, so the capital allocation efficiency is low, thus the firm value will be adversely affected. To sum up, when the more capital is put into more efficient business activities, it will enhance the value of the firm; when more capital is put into the less efficient business activities, it will have negative effect on the firm value. In this regard, this paper makes the following hypotheses: H1: An increase in the level of capital misallocation can significantly reduce firm value. 4. Asset specificity, capital misallocation and firm value In transaction cost economics, the asset specificity of a firm is a key determinant of the firm's capital structure. Asset specificity refers to investment in durable goods to support a particular transaction (O. Willamson, 1988), the use of assets with a high degree of specificity is single, with large loss in value at the time of realization, and the use of assets with a low degree of specificity is wide, with small loss in value at the time of realization. The existing research on asset specificity focuses on asset specificity and debt financing, asset specificity and capital structure. Many scholars at home and abroad use different measurement methods to draw a more consistent conclusion that asset specificity level is negatively related to debt financing (Balakrishnan, Fox, 1993; Cushing, Mc Cart, 1996; Cheng Hongwei, 2004); In the aspect of asset specificity and capital structure, the empirical study on the relationship between asset specificity and capital structure at home and abroad is uncertain, some scholars believe that asset specificity and capital structure is positively correlated (Wang Yonghai, Fan Ming, 2004), while other scholars believe that asset specificity and capital structure is negatively correlated(cheng Hongwei, 2004; Li Qingyuan, Wang Yonghai, 2006). Further attention is paid to the impact of asset specificity on capital misallocation and firm value among business activities. For the firm's accounting performance, because of the limited redefinition of the asset specificity (Williamson, 1988), business activities with high asset specificity will bring about a higher exit barrier, greatly enhancing the costs

13 used for adjusting capital allocation when the capital misallocation is serious, which will increase the impairment of capital misallocation on accounting performance. So the increased asset specificity will increase the negative impact of capital misallocation on firm accounting performance. However, unlike the accounting performance which reflects the current performance of the firm, the market performance (Tobin s Q) can be regarded as the shareholders valuation of the firm to some extent and the discount of the future firm value. For this reason, many scholars in China regard it as a proxy for the growth of firms (Xiang Zhaojin, Xie Ming, 2003; Yang Xingquan et al., 2016). Therefore, in the analysis of market performance, not only the current effect of asset specificity on capital misallocation which will influence the market value, but also the impact of future earnings should be taken into account. Domestic and foreign scholars (Collis and Montgomery, 1998; Li Qingyuan et al., 2007)found that firms with high asset specificity often because it is at the highly competitive product market, and the more intense competition in the product market, the firm is more likely to invest assets with higher specificity in order to obtain more large competitive advantages. When the capital flows to business activities with lower efficiency at that time, it brings relatively low income to the firm, but when the firm analyzes rationally its own business environment and its own advantages and formulates a reasonable development strategy, it will suffer the reduction of current income due to capital misallocation, in order to achieve long-term business goals, increase the investments in intangible assets, fixed assets, in order to obtain greater competitive advantage in the future. On the one hand, the behavior of investing specific assets will send a positive signal to investors to offset the negative impact of some capital misallocation on market value, on the other hand, the assets with greater specificity will bring the competitive advantage to the firm in the future market competition, thus offsetting the part of reduction in income due to current capital misallocation. Therefore, the increase of asset specificity will alleviate the negative impact of capital misallocation on enterprise market performance. To sum up, this paper proposes the following hypotheses: H2a: The increase in asset specificity will exacerbate the damaging effects of

14 capital misallocations of business activities on accounting performance. H2b: The increase of asset specificity will mitigate the damaging effects of capital misallocations of business activities on market performance. III. Data, Variables, and Empirical Specifications 1. Sample selection and data sources In this paper, A-share listed companies from 2006 to 2015 are selected as the research object. The depreciation data of the inventory depreciation reserves, impairment of other receivables, impairment of prepayments and provision for impairment of accounts receivable used in this paper are derived from the working capital database of Chinese listed companies from the China Enterprise Working Capital Management Research Center, and other data are from the CSMAR and CCER databases. The data processing and statistical analysis software used in this study is Stata12.0. In this paper, the initial samples were screened as follows:(1) excluding financial listed companies;(2) excluding ST companies; (3) excluding new listed companies in 2015; and (4) excluding listed companies with missing and unusual data. After the above screening, this paper obtained a total of 16,398 "company - annual" sample observations. In order to control the extreme value problem, the extreme values of 0-1% and 99% -100% of all continuous variables are processed by Winsorization method, which is equal to 1% and 99% quantiles respectively. 2. Empirical model Based on the models and variables of Anderson, Reeb (2003), Shao Shuai and Lu Changjiang (2015), Zhongkai et al. (2016) and JinYuchao (2016), the following model is constructed: PERFORM = β 0 + β 1 CMs + β 2 ASI + β 3 TA + β 4 Lev + β 5 Growth + β 6 Sales + β 7 FCF + β 8 Prfrm + β 9 Age + β 10 SOE + β 11 Top1 + β 12 Board + β 13 IND + β 14 Pay + β 15 Dmeet + Industry + Year + ε 1 Model 1 is used to test hypothesis H1. In testing hypothesis H2, the cross item of

15 asset specificity and capital misallocation is added to analyze the effect of asset specificity on capital misallocation and firm value. PERFORM = β 0 + β 1 CMs + β 2 ASI + β 3 ASI CMs + β 4 TA + β 5 Lev + β 6 Growth + β 7 Sales + β 8 FCF + β 9 Prfrm + β 10 Age + β 11 SOE + β 12 Top1 + β 13 Board + β 14 IND + β 15 Pay + β 16 Dmeet + Industry + Year + ε 2 3. The selection and defining of variable (1) Capital Misallocation This paper chooses Capital Misallocation (CMs) as proxy variable. When CMs are negative, the symbols of unit risk rate of return and funds are opposite, and the capital is seriously misallocated; when CMs are positive, the symbols of unit risk rate of return and funds are the same, and the misallocation of capital is not serious; the smaller the value of CMs, the more serious of the misallocation of capital. (2) Assets Specificity The mature method is long-term asset approach on the measurement of asset specificity. Based on precious researches (Chen Hongwei, 2004; Zhou Yuhao, Zhang Shengyong, 2014), this paper uses the ratio in which the sum of net value of fixed assets, construction in process, and intangible assets account for the total corporate capital as a proxy variable for asset specificity. Besides, the denominators in previous researches mostly are total asset, without considering the impact of impairment provision and operating liabilities. This is different from this paper. Therefore, this paper adjusts it to the index of total capital. Table 1 is the index formula. (3) Other variables In terms of proxy variable of firm value, in reference to relevant documents (Anderson, Reeb, 2003; Shao Shuai, Lv Changjiang, 2015), this paper use accounting performance and market performance to evaluate firm value. The ROA is used as a measurement for accounting performance; Tobin s Q is for market performance. TOBIN S Q= (market value of shareholders' equity + the book value of liabilities)/ the book value of assets. Table 2 is the relevant variables in this paper.

16 Table 2 The definition of variables Variables Name Illustration Capital misallocation CMs Capital misallocation = (Return on Investment Capital/Investment Risks-Return on Operating Capital/ Operating Risks) (The ratio of investment capital between total capital-the ratio of operating capital between total capital) Assets Specificity ASI The ratio between the total sum of net value of fixed assets, construction in process, and intangible assets, and total corporate capital Accounting performances ROA The net profit deducted from extraordinary gains and losses/ total assets Market performance Tobin s Q (The market value of corporate stock+ the book value of liabilities)/ total assets Scale of company TA The natural logarithm of total assets Asset-liability ratio Lev total liabilities/total assets Enterprise growth Growth (The operating income of this year-the operating income of last year)/ the operating income of last year Business scope Sales The natural logarithm of operating income Free cash flow FCF NOCF/total assets The business circumstance of last year Prfrm The profits of last year/ the total assets of last year Enterprise age Age The current year-the year that enterprise established The nature of property right SOE Dummy variable. When it is state-owned enterprise, the value is 1, otherwise, the value is 0. Ownership concentration Top1 The share proportion of the largest shareholder Number of directors Board The numbers of board of directors The ratio of independent directors IND The ratio of independent directors between board of directors Executive pay Pay The natural logarithm of the total sum of board of directors, supervisors and senior executives that year (except the allowance of independent directors)

17 The frequency of board meeting Dmeet The annual board meetings Industry Dummy Industry There are 10 Industry Dummy according to the standard of classification of CSRC (China Securities Regulatory Commission) in The annual dummy variables Year There are 10 annual dummy variables after controlling the impact of different year IV Empirical Test 1. Descriptive statistics Table 3 The results of descriptive statistics Variable N Mean Sd Min P25 P50 P75 Max ROA Tobin s Q CMs ASI TA Lev Growth Sales FCF Prfrm Age SOE Top

18 Board IND Pay Dmeet Table 4 The capital misallocation and firm value, assets specificity: the results of group T Variables CMs<0 CMs 0 MeanDiff N Mean N Mean ROA *** Tobin s Q *** ASI *** TA *** Lev ** Growth *** Sales *** FCF *** Prfrm ** Age *** SOE ** Top *** Board IND Pay *** Dmeet * ** *** Indicate significance levels at and 0.01,respectively,using two-tailed tests. Table 3 is the results of descriptive statistics. Table 4 lists the T-test results of groups based on the indicators of capital misallocation. From Table 3 and Table 4, the mean value of ROA is At those enterprises with serious capital misallocation, the mean value of ROA is Obviously, it is lower than those enterprises with less serious capital misallocation, whose mean value of ROA is The T-test shows that the capital misallocation in operating time can affect the accounting performance to some extent.

19 The mean value of Tobin s Q is The mean value of Tobin s Q is in the groups without serious capital misallocation, which is significantly lower than those groups with serious capital misallocation whose mean value of Tobin s Q is It is contrary to the hypothesis and has to reevaluation in the regression. The mean value of assets specificity (ASI) is The mean value of ASI is in those enterprises without serious capital misallocation, which is significantly lower than those groups with serious capital misallocation whose mean value of ASI is To some extent, the ASI has some impacts on capital misallocation. The average life of listed companies is years. Compared to foreign listed companies, Chinese listed companies are younger. The mean value of the share proportion of the largest shareholder is 35.87%, with median of 33.84%. This shows that in those samples, it is a problem that the largest shareholder holds the most shareholders in listed companies, and it is easy to cause proxy problem and damage the interests of small and medium shareholders. The mean value of index of capital misallocation is This paper made a further analysis to analyze the detailed features of the index. The results are shown in Table 5. Among all enterprises after one-year observation, there were 5862 enterprises with serious capital misallocation, accounting for 35.75% of all samples. In all samples with serious capital misallocation, there are 3900 samples which high return is result from its unit venture investment activities. However, the samples with too much funds to the operating activities account for 65.29% of all samples due to the capital misallocation. This shows that most enterprises ignore the importance of investments because of their traditional business concept, in which they invest their capital into activities with low efficiency so that it causes serious capital misallocation. Among all the industries, three industries, accommodation and catering and hotel services, education and information transmission, software and IT services, their capital misallocation are the most common, accounting for 51.95%,50.00% and 48.41% respectively; Hygiene and social work, building industry and electricity, heating power, fuel gas, water production and supply, the degree of these three enterprises with capital misallocation is lighter, accounting for 21.05%, 26.89% and 27.51% respectively. Except that hygiene and social work accounts for the most funds to the investment activities, building industry and

20 electricity, heating power, fuel gas, water production and supply have more funds to the operating activities. With further analysis of the type of mismatches, education, hygiene and social work, culture, sports and entertainment industry and other industries, their funds to the investment activities have higher ratio of serious capital misallocation, accounting for 100%, 100% and 71.19% respectively. To some extent, this shows that these industries are keen to capital operations and sometimes these capital operations are blind investments; agriculture, forestry, husbandry and fishery, mining industry and electricity, heating power, fuel gas, water production and supply, their too much funds to the operating activities have higher ratio of serious capital misallocation, accounting for 87.61%, 86.05% and 85.96% respectively. To some extent, this shows that traditional industries are opt to operating activities and ignore investments. Therefore, there is high return of venture investment, and they would like to invest capital to operating activities.

21 Table 5 The analysis of the firm capital misallocation in different industries Industr y Code Name of industry The total enterprise s The total numbers of serious capital misallocation The ratio of the numbers of serious capital misallocation The multi-matching of investment activities The multi-matching of operating activities enterprises enterprises No. Ratio No. Ratio A Agriculture, forestry, husbandry and fish ery % % % B Mining industry % % % C Manufacturing industry % % % D Electricity, heating power, fuel gas, water production and supply % % % E Building industry % % % F Wholesale and retailing % % % G Transportation, storage and mail business % % % H Accommodation and catering and hotel % % %

22 I services Information transmission, software and IT services % % % K Real estate % % % L Leasing and business service industry % % % M Scientific research and technical service % % % N O Water conservancy, environment and Public Facility Management Residents services, maintenance and other services % % % % % % P Education % % % Q Hygiene and social work % % % R Culture, sports and entertainment industry % % % S Comprehensive industry % % % Amount % % %

23 Table 6 Correlation matrix ROA Tobin s Q CMs ASI TA Lev FCF Age SOE IND ROA 1 Tobin s Q 0.180*** 1 CMs 0.115*** *** 1 ASI *** *** 0.125*** 1 TA 0.062*** *** 0.091*** 0.141*** 1 Lev *** *** 0.030*** 0.221*** 0.342*** 1 FCF 0.338*** 0.081*** 0.087*** 0.258*** 0.041*** *** 1 Age *** *** *** 0.213*** 0.316*** *** 1 SOE *** *** *** 0.295*** 0.240*** 0.051*** 0.325*** 1 IND *** 0.015* *** *** *** *** *** 1 * ** *** Indicate significance levels at and 0.01,respectively,using two-tailed tests. Table 6 lists the correlation coefficients of the main variables in this paper. The result shows that there is a significant positive correlation between the capital misallocation index and ROA, asset specificity, firm size and asset-liability ratio. To some extent, it shows that the slighter the degree of capital allocation (or the larger the capital allocation index), the larger the firm value. And this result is the same with the results of descriptive statistics. There is no collinearity for the correlation coefficient between variables is not high.

24 2. The empirical results and empirical analysis (1) Capital misallocation and firm value In order to control the influence of individual heterogeneity which might be omissive and keep unchanged with time going by has on regression results, firstly, this paper used Hausman to test model s choice between fixed effect and random effect, and the result showed that fixed effect is better. Therefore, this paper used two-way fixed effect model to study the influence that capital misallocation has on firm value. Table 7 was the regression results of fixed effect model between capital misallocation and firm value. Among this table, line (1) and line (2) only controlled the fixed effect of industry and year respectively, and ROA and Tobin s Q were taken as regression results of explanatory variables. From this, we could see that the coefficient of capital misallocation was positive, which was and respectively. And ROA was significant at the level of 1%, which indicated that the greater the capital misallocation index was (that is, the slighter the degree of capital misallocation), the greater the ROA. The coefficient of Tobin s Q was not significant, which might have relations with the missing of control variables. In line (3) and (4), there were other control variables that affect firm value. As a result, when explanatory variables were ROA and Tobin s Q, the coefficient of capital misallocation was still positive, which was and respectively, and they were significant at the level of 1%. This showed that a unit decrease of capital misallocation, and units of ROA and Tobin s Q respectively will decline. It indicated that the increase of the degree of firm capital misallocation would significantly damage firm value. The regression result supported the hypothesis H1. Other variables in the regression results were the same as the hypothesis, and the results were the same as those of Shao Shuai (2015). Table 7 Capital misallocation and firm value - Fixed effects regression results (1) (2) (3) (4) ROA Tobin s Q ROA Tobin s Q

25 CMs ASI TA Lev Growth Sales FCF Prfrm Age SOE Top1 Board IND Pay Dmeet cons *** *** *** ( ) (0.5895) ( ) (2.7114) *** *** ( ) ( ) *** ( ) ( ) *** *** ( ) (3.8254) *** *** ( ) (8.5547) *** *** (4.6076) ( ) *** *** ( ) (5.1579) *** *** (8.0469) (5.0005) *** *** ( ) ( ) *** ( ) ( ) *** (5.2396) (1.3699) *** ( ) (0.4599) (1.4599) (0.7305) *** *** ( ) (5.1904) *** *** (3.7530) (7.8355) ** * *** *** (2.3168) (1.8750) ( ) ( ) Industry Fixed control control control control

26 Effect Year Effect Fixed control control control control N r r2 a * ** *** Indicate significance levels at and 0.01,respectively,using two-tailed tests. (2) The regression analysis of the influences that capital misallocation and the nature of property right have on firm value In order to test whether the reduction of asset specificity would mitigate the adverse effect of capital misallocation has on firm value, this paper added the cross term of the variables of asset specificity and capital misallocation into model 1 and therefore we got model 2. Likewise, to control the individual differences of firms which keep unchanged as time goes by, this paper used fixed effect to have regression. And the results were shown in Table 8. Among this table, line (1) and line (2) only controlled the fixed effect of industry and year respectively, and ROA and Tobin s Q were taken as regression results of explanatory variables. In line (3) and (4), there were other control variables that affect firm value, and ROA and Tobin s Q were also taken as explanatory variables. In Table 8, considering the regulation of asset specificity, the relation between capital misallocation index and firm value was still positive, which further verified the hypothesis H1. Before adding other control variables, there was a significant positive correlation at the level of 1% between the cross term of asset specificity and capital misallocation (ASI*CMs) and ROA. The Tobin s Q regression result was in a significant negative correlation at the level of 10%. When adding other control variables, there was a significant positive correlation of ROA at the level of 5%, while a negative correlation of Tobin s Q at the level of 5%. The regression result showed that the increase of asset specificity can significantly aggravate the degree of capital misallocation, and therefore have a negative influence on accounting performance. However, it will significantly alleviate the negative impact that the