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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Multinational Financial Management, Volume 23, Issue 3, July 2013, Pages 146–165
This study investigates whether and how banks’ lending incentives influence firms’ investment behaviors in China. First, empirical results show that loans granted to politically connected firms are less influenced by those firms’ profitability and tangibility. Second, political connection is a violation factor in debt markets, and our study finds that firms with political ties invest less efficiently than firms without political ties when they can access abnormal debt. Finally, we find that regional development with regard to market development and government quality improvement reduces the negative impact of politically connected lending on firms’ investment efficiency.
Based on the data from the national bureau of statistics of China (NBS), fixed-asset investment accounts for nearly 50% of China's GDP growth. Nevertheless, many scholars and practitioners are becoming increasingly concerned with whether such investment-driven economic growth can be sustained going forward. A parallel question we would like to raise is how much of such investment is actually excessive and how much of such excessive investment could be reduced. By “excessive investment” we mean the investments that are of low efficiency; although they contribute to the GDP, they barely create value rather than generate excessive supplies here and there. In the corporate finance literature, the seminal work by Modigliani and Miller (1958) suggests that, in perfect capital and credit markets, the investment behavior of a firm is irrelevant to its financing decisions. However, in the presence of market imperfections, any financing frictions should reflect on firms’ investment decisions. For example, information asymmetry between insiders and outsiders could affect firms’ cost of capital and cause investment distortion. In addition to information asymmetry and agency problems, improper incentives or agency problems in the credit market (hereafter, soft lending1) are financing friction of consequence, which undermines their primary function of allocating scare capital efficiency. This is a particularly serious problem in emerging markets, like China, with a lack of efficient law enforcement and property rights protection. For instance, 461 cases of bank fraud involving more than one million Yuan (US$125,000) each were uncovered in China in 2005 (Barth et al., 2009). Therefore, this study will identify a pronounced type of soft lending – lending based on political ties – in China and then investigates whether political-connection-based soft lending influences firms’ behaviors with regard to investment decisions, the key determinant of firms’ productivity. Relationship-based transactions are popular in the business world in emerging markets, and one important example of such a relationship is political ties. For example, empirical evidence indicates that, in some countries, politically connected firms have preferential access to debt financing (e.g., Cull and Xu, 2005 and Faccio, 2006). In addition, a large amount of literature documents that politically connected firms outperform companies without relationships when institutional constraints are weak (e.g., Dinc, 2005, Fisman, 2001 and Johnson and Mitton, 2003). However, prior research keeps silent about the related cost of political connection to firms and to the whole economy. Our paper will shed light on this issue by addressing two fundamental questions: do politically connected firms have better access to bank loans? And what is the economic consequence of such political-connection-based lending? Many companies in China are led by politically connected CEOs who have served as bureaucrats in central or in local government (Fan et al., 2007a and Fan et al., 2007b). Almost 27% of listed companies are led by politically connected CEOs2 in China, which provide a semi-experimental setting to investigate this interesting issue. We argue that politically based lending could cause misallocation of resources by banks and reduce investment efficiency in China. China has a big, fast-growing economy but a weak legal institution and a less-developed financial market. The “Big Four” banks dominate Chinese banking system,3 which are ultimately controlled by central or local government, and consequently, the government has huge influences on banks’ operations, including lending decisions. Thus, it is easier for government officers to help politically connected firms to receive bank loans regardless of the firms’ performance and creditworthiness.4 Prior research indicates that political connection is a rent-seeking tool to extract private benefits. In the context of China, managers could use their political connection to get bank loans as much as they can. However, after political connection brings more funds to firms, firms will invest more whether they have promising investment opportunities or not. For example, managers can pursue “empire-building” and expand firms fast, which increases the likelihood of promotion and compensation of CEOs. Furthermore, banks as major fund providers could play an important role in governing firms in corporate governance literature (Shleifer and Vishny, 1997). However, politically connected lending is accompanied by less monitoring posted by banks, which can reduce managers’ incentives to invest efficiently but provide convenience for managers to pursue personal benefits. In our study, we use a sample of 8148 Chinese firm-year observations over the period from 1999 to 2009 to investigate the issue. Our study finds that loans granted to politically connected firms are influenced less by those firms’ profitability and tangibility. In particular, a negative relationship between firms’ political connection and loan-profitability sensitivity is stronger for stated-owned enterprises (SOEs) than for non-SOEs. Furthermore, politically connected firms relied on their mortgage assets less to access a loan, especially non-SOE firms. This result is also consistent with prior research documenting that the cultivation of political connections helps non-SOEs to overcome market and state failures and avoid ideological discrimination in China (Li et al., 2008). In terms of investment efficiency measures, this study follows the idea presented by Bushman et al. (2011): investment growth is related to changes in investment opportunities (marginal Q). Our empirical results show that firms with political ties invest less efficiently than firms without political ties, especially for low-growth firms and SOEs. Moreover, firms with political ties invest less efficiently than firms without political ties only when politically connected firms get access to abnormal loans from banks. These empirical results suggest that easy access to financing intensifies agency problems in firms with political ties. China's highly decentralized political and economic systems provide large variation in institutional environments across its provinces and special districts, while its language, culture, and social norms remain unified (Fan et al., 2007a and Fan et al., 2007b). This provides a natural setting in which to examine how institutional constraints affect firms’ political connection influence on firms’ investment efficiency. It is predicted that higher regional GDP, better government quality, and better market development can increase the financial market development, reduce the ability of politically connected firms to access bank debt, and thus reduce the possibility of wasting money by politically connected firms. In the empirical tests, we find that, in regions with higher marketization level and better government quality, political-connection-based lending is less likely to hurt firms’ investment efficiency. In sum, improper incentives in bank lending destroy economic growth because of misallocation of resources among firms and also because of less incentive to monitor firms’ project selection. The empirical results indicate that, in the Chinese context, non-economically motivated bank lending comes at a significant cost to the whole economy's productivity. Analysis of how banks’ lending incentives influence firms’ investment decision making contributes to our understanding of the link between banking system development and firm value. Here our study focuses on whether bank lending incentive distortion, proxied by political ties, affects firms’ investment efficiency, a crucial determinant of firm value. It adds another dimension to our understanding of the mechanism underlying banks’ lending decision that has potentially significant economic consequences. Our study provides empirical evidence that relationship-based lending could hurt firms’ efficiency with regard to investment efficiency. Furthermore, there is now a growing body of literature that documents that firms can benefit in many ways from their connections; for example, they can get preferential access to markets and financing, they can sell to government entities at high-rent prices, they can get protection from the legal system, and they are protected from domestic and foreign competition. These relationships appear to be particularly valuable in emerging markets such as China. On the other hand, connections can be costly if firms abuse these preferential rights; for instance, they can easily access debt financing but no promising projects. Also, connection-based lending could hurt promising firms because it makes access to financing for those firms more difficult to obtain. The remainder of the paper is organized as follows. Section 2 introduces the banking industry in China and develops the main hypotheses. Section 3 describes the data, sample, and research design. Empirical results and sensitivity tests are presented in Section 4. Section 5 presents conclusions and limitations.
نتیجه گیری انگلیسی
Despite recent studies that document the value of politically connected CEOs on firms’ value, there is little evidence on the cost of the political connection of CEOs. This paper studies the cost of the political connection of CEOs on banks and on firms themselves. The analysis is based on a sample of 4012 firm-year observations of listed Chinese firms from 1999 to 2005. First, being connected with bureaucrats provides firms with a comparative non-economic advantage of access to debt, particularly long-term debt in China. My results show that loans granted to politically connected firms are less sensitive to those firms’ profitability. The findings suggest that political connection of CEOs is a significant violation factor in the debt market and causes sub-optimal lending decisions by banks. Second, any friction in the financial market would be reflected in firms’ investment decision. In China, banks are still the most important financing resources for firms. The distortion factor, that is political connection, could affect firms’ investment decisions. As predicted, I find that firms with political ties invest less efficiently than firms without political ties. Moreover, the negative relationship between banks’ lending incentives related to political connection and firms’ investment efficiency is stronger for SOE firms and low-growth firms. Finally, I find that regional development with regard to financial development and government quality improvement reduces the misallocation of credits and improves firms’ investment efficiency.