Bank Lending Incentives and Firm Investment Decisions in China

Abstract:     
This is the second part of my dissertation. In this study, we examine whether and how incentives in bank lending, in emerging market like China, influence firms’ investment behaviors, the key determinant of firms’ productivity. First, being connected with bureaucrats provides firms with a comparative non-economic advantage of access to debt in China. Our empirical results show that loans granting to political connected firms is less sensitive to those firms’ profitability, which is consistent with “rent-seeking” hypothesis. Second, political connection is a violated factor in debt markets and politically connected lending is accompanied by less monitoring posted by banks. Consequently, we find that firms with political ties invest less efficiently than firms without political ties when they can access to abnormal debt through political tie. Moreover, the negative relation between politically connected lending and firms’ investment efficiency is stronger for SOE firms and low growth firms. Finally, we find that region development with regard to financial development and government quality improvement reduces politically connected lending’s negative impact on firms’ investment efficiency. In sum, soft lending, like politically connected lending, destroy economic growth because of misallocation of resources among firms and also because of less incentive to monitor firms’ project selection.

Keywords: bank lending, investment

JEL Classification: G21, G31

working papers series