Financial constraints and systematic risk: Theory and evidence from China

Financial constraint, which is very common in emerging markets like China, have significant effects on firmspsila investing and financing decision in imperfect markets. The extent to which firms are financially constrained determines which type of financing and investing policy firms may choose, and thereby affects firmspsila sensitivity to the fluctuation of aggregate economy, i.e. systematic risk. We develop the Conservative Investing Hypothesis and Aggressive Financing Hypothesis supporting financial constraints would restrain and magnify systematic risk respectively. The former assumes firms tend to reduce investment spending when financially constrained, and thereby suffer less covariation with aggregate outputs; while the latter assumes firms would rather turn to aggressive financing policy when they could not finance adequate fund, so these firms seem more sensitive to macroeconomic shocks. We test these hypotheses with an unbalanced panel data of 189 listed firms during 2000 to 2006, finding samples more financially constrained have lower systematic risk, providing evidence to the Conservative Investing Hypothesis.