Why Member Firms Hold More Cash When They Have Access to the Business Group’s Finance Company? Empirical Evidence of Tunneling from China

Abstract

In China, firms within a business group may be able to access funds provided by a parent-owned finance company within the business group. We provide direct evidence of ‘tunneling’: where the parent of the business group requires member firms to increase their cash holdings through deposits in the group’s finance company and invest the collected deposits in the interbank market or other financial institutions, instead of lending to business group members. The parent of the business group reaps most, if not all, the profits from the finance company, at the expense of member firms’ increased holding in cash. We use the Shenzhen 2007 Anti-tunneling Guidance as the exogenous shock to identify the main results. Our results cannot be explained by the alternative hypotheses that member firms hold more cash holdings as a result of reduced bank monitoring or the parent’s incentive to reallocate capital more efficiently.

Keywords: Finance company, Tunneling, Business group, cash holding, shadow banking

JEL Classification: G23, G39