Research Article ISSN 2304-2613 (Print); ISSN 2305-8730 (Online) Copyright © CC-BY-NC, Asian Business Consortium | ABR Page 121 Does Financial Flexibility foster Investment Efficiency? Evidence from an Emerging Market Md. Rashidul Islam 1 , Monirul Alam Hossain 2* , Mohammad Shamsu Uddin 3 , Dawit Teclemariam Bahta 4 1 School of Accounting, Dongbei University of Finance and Economics, Liaoning Province, Dalian, CHINA 2 Professor and Chairperson, Department of Business Administration, Bangladesh University, Dhaka, BANGLADESH 3 School of Economics and Management, Dalian University of Technology, Dalian 116024, CHINA 4 School of Business Administration, Dongbei University of Finance and Economics, Liaoning Province, Dalian, CHINA * E-mail for correspondence: monirulhossain@gmail.com https://doi.org/10.18034/abr.v10i2.476 ABSTRACT This research aims to examine the relationship between financial flexibility and investment efficiency empirically, i.e., how financial flexibility effects suboptimal investments and efficiency. To attain the research objectives, we used panel data for 18 years (2000-2017) obtained from the CSMAR database; and also used the GMM estimation technique for research outcome. Our empirical results reveal that financial flexible firms can reduce the suboptimal investment by increasing investments compared to the inflexible firms and increases the investment efficiency. Also, financially flexible firms generate additional power to borrow external finance by showing a significant positive relationship with current and expected leverage. This research considers China as an emerging economy that is in the transition of being a developed country with a unique set of corporate governance, which ensures the independence of independent directors by providing authority to disclose important board decisions to the public. Besides, the governance system is highly monitored by the government, which in turn reduces and information asymmetry and enact to provide investment efficiency. Thus, the outcome of this research offers several conceptions for researchers and managers, which may be useful for both emerging and advanced countries. The results indicate that financial flexibilities lead to excess debt capacity, and this capacity can be used in the bad time when external financing is challenging to fund profitable projects, and also financial flexibility can be used to exploit lucrative projects and reduce the underinvestment or overinvestment entailing investment effectiveness. Previous research addresses the issue related to cost and benefit, information asymmetry, ownership concentration, and firms’ propensity to financial flexibility. A little research conducted on financial flexibility and investment efficiency in the developed market (in Europe and USA), and thus the issue of and financial flexibility measured in unused debt capacity and investment efficiency, is one of the fundamental research in the emerging economy. Key words: Financial Flexibility, Investment Efficiency, Emerging Economy INTRODUCTION Financial flexibility is the firm’s capability to raise economic resources to respond to expected investment and expansion opportunities as well as provide strength to face any future unexpected events and contributes to maximizing firm’s value (Cherkasova and Kuzmin, 2018; Ma and Jin, 2016; Denis and McKeon, 2009; Byoun, 2007; Bates et al., 2009). It is also dubbed as a strategic tool which enables firm’s to avoid financial distress and instigates investment in the positive net present value projects (Bonaimé et al., 2013; Ma and Jin, 2016; Bolton et al., 2019), and financial flexible firms enjoy more comfortable access to capital markets and raise funds at lower costs to fund new growth opportunities even if in the crisis (Arslan- Ayaydin et al., 2014; Oded, 2019). The agency theory describes the agency costs involved in the executive's benefits at the cost of owners’ (Jensen and Meckling, 1976). The executives who are in control of corporate affairs may not pursue activities for the principal benefits, which in turn involve a cost of