Do firms care about investment opportunities? Evidence from China

What drives a firm's investment decisions in China? While most literature focuses on the role of financial factors (such as cash flow), we explore this most important question in corporate finance from the perspective of economic fundamentals. Using a large number of proxies for investment opportunities and a variety of econometric approaches, our empirical results show that it is private firms that make the most of all types of investment opportunities in China. State-owned enterprises respond more to the investment opportunities from the supply side, but much less so to demand-side shocks and future profitability. Financial sector development is found to be conducive to the improvement of the investment efficiency of private firms by making them take better advantage of all types of investment opportunities in their decision-making. Our research calls for further institutional and financial sector reforms in China.