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Tunneling through related-party loan guarantees: evidence from a quasi-experiment in China

Abstract

We use the balance of outstanding related-party loan guarantees (RPLG) issued by Chinese listed firms as a direct measure of tunneling. By adopting institutional perspectives and a difference-in-differences approach, we show that firms increased RPLG after the 2008 enterprise income tax reform. More importantly, domestic firms had larger increases of RPLG compared to foreign-invested firms during the post-reform period. This treatment effect is in line with domestic firms’ higher exposures to weak corporate governance, inefficient banking system, and weak legal environment in China. Further analysis shows that the treatment effect is stronger for private controlled domestic firms than government controlled domestic firms. Finally, the propensity of tunneling also increased after the tax reform for all types of firms but the treatment effects on the propensity of tunneling are insignificant. Our findings are robust in models control for firm exposure to the global financial crisis of 2008–2009.

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Notes

  1. 1.

    See Cheng (2009) for an analysis of China’s stock market in the first 10 years.

  2. 2.

    The CSRC guidelines specifically require banks to carefully examine financial soundness of the RPLG issuing firms when processing loan applications.

  3. 3.

    According to Berkman et al. (2009), the identity of the block holder is more important than its percentage holding.

  4. 4.

    Listed firms with consecutive annual losses are under special treatment and labelled as “ST” firms as warning to investors for possible delisting.

  5. 5.

    3396 observations are on foreign invested firms and 3173 are on domestic firms. We exclude 15 firm-year observations subject to tax rates other than 15 and 33 % as the ownership of these firms cannot be clearly identified given the statutory tax rates.

  6. 6.

    The use of industry adjusted leverage ratio follows Liu and Tian (2012). The adjusted excess leverage ratio equals to firm leverage ratio minus the industry mean leverage ratio. We also find that using industry median adjusted values provides similar results.

  7. 7.

    The controlling shareholder may “prop up” rather than “tunnel” through RPT before seasonal equity offering and rights issues according to Peng et al. (2011).

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Correspondence to Wei Huang.

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Huang, W. Tunneling through related-party loan guarantees: evidence from a quasi-experiment in China. Rev Quant Finan Acc 47, 857–884 (2016). https://doi.org/10.1007/s11156-015-0523-3

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Keywords

  • Tunneling
  • Related-party
  • Tax
  • China

JEL Classification

  • G32
  • G34
  • G38