State Ownership, Soft-Budget Constraints, and Cash Holdings: Evidence from China's Privatized Firms

16 Pages Posted: 19 Dec 2014 Last revised: 16 Mar 2015

See all articles by William L. Megginson

William L. Megginson

University of Oklahoma

Barkat Ullah

Morgan State University

Zuobao Wei

University of Texas at El Paso

Date Written: December 17, 2014

Abstract

We study the relation between state ownership and cash holdings in China’s share-issue privatized firms from 2000 to 2012. We find that the level of cash holdings increases as state ownership declines. For the average firm in our sample, a 10 percentage-point decline in state ownership leads to an increase of about RMB 55 million in cash holdings. This negative relation can be attributable to the soft-budget constraint (SBC) inherent in state ownership. The Chinese financial system is dominated by the state-owned banks, an environment very conducive for the SBC effect. We further examine and quantify the effect of state ownership on the value of cash and find that the marginal value of cash increases as state ownership declines. The next RMB added to cash reserves of the average firm is valued at RMB 0.96 by the market. The marginal value of cash in firms with zero state ownership is RMB 0.36 higher than in firms with majority state ownership. The SBC effect exacerbates agency problems inherent in state-controlled enterprises, contributing to their lower value of cash.

Keywords: Privatization, State ownership, Soft-budget constraints, Cash holdings, China

JEL Classification: G32, G34, G38

Suggested Citation

Megginson, William L. and Ullah, Barkat and Wei, Zuobao, State Ownership, Soft-Budget Constraints, and Cash Holdings: Evidence from China's Privatized Firms (December 17, 2014). Journal of Banking and Finance, Vol. 48, 2014. Available at SSRN: https://ssrn.com/abstract=2539806

William L. Megginson

University of Oklahoma ( email )

307 W Brooks, 205A Adams Hall
Norman, OK 73019
United States
(405) 325-2058 (Phone)
(405) 325-1957 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/M/William.L.Megginson-

Barkat Ullah

Morgan State University ( email )

Baltimore, MD 21251
United States

Zuobao Wei (Contact Author)

University of Texas at El Paso ( email )

500 W. University Ave.
El Paso, TX 79968
United States
915-747-5381 (Phone)
915-747-6282 (Fax)

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