Bank Work Experience Versus Political Connections: Which Matters for Bank Loan Financing?

AuthorXiaofei Pan,Gary Gang Tian
DOIhttp://doi.org/10.1111/irfi.12225
Published date01 June 2020
Date01 June 2020
Bank Work Experience Versus
Political Connections: Which
Matters for Bank Loan Financing?*
XIAOFEI PAN
AND GARY GANG TIAN
School of Accounting, Economics and Finance, University of Wollongong,
Wollongong, New South Wales, Australia and
Department of Applied Finance, Macquarie University, Sydney, New South Wales,
Australia
ABSTRACT
This paper examines how bank lending decisions are affected either by exec-
utivesconnections with banks, through their former banking experience, or
by their political connections with governments, using a sample of bank
loans granted to Chinese listed non-state-owned enterprises (SOEs) from
2003 to 2010. We nd that bank loans are more closely related to protabil-
ity for rms with bank connections, while rmspolitical connections
weaken this relationship. We further nd that the inuence of bank connec-
tions is more signicant for rms from less supported industries or less devel-
oped regions. Furthermore, rms with bank connections are less likely to
become nancially distressed after the initiation of their bank loans and
experience higher future stock returns, while rms with political connections
experience the opposite outcome. Overall, our results indicate that in the
context of a relationship-based economy like China, rmsconnections with
banks create value by alleviating information asymmetry and improving
bankslending decisions, while political connections result in capital misallo-
cation and subsequent deterioration in performance.
JEL Codes: E51; G32; G34
Accepted: 19 July 2018
* For valuable comments on the current and earlier versions of this paper the authors thank Meijun
Qian, Phong Ngo, Joseph Fan, Meng Rui, Gary Twite, Collin Xu, Xi Wu, Guanmin Liao, Qingquan
Xin, Chaohong Na and participants of seminars organized by the School of Accountancy, Central
University of Finance and Economics, December 12, 2012; the Business School, University of Inter-
national Business and Economics, December 13, 2012; Nottingham University Business School, The
University of Nottingham Ningbo, December 12, 2013; the School of Finance, Actuarial Studies and
Applied Statistics, College of Business and Economics, Australian National University, October
10, 2013 and the China Finance Review International Conference, Shanghai, July 8, 2013; the
China International Conference in Finance (CICF), July 1013, 2013; the Asian Finance Association
Annual Meeting, Nanchang, July 1517, 2013; the World Finance & Banking Symposium, Beijing,
December 1617, 2013; and the 2014 CICF in Chengdu, China, on July 1013, 2014.
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 20:2, 2020: pp. 351382
DOI: 10.1111/ir.12225
I. INTRODUCTION
Recent literature has documented that the bankrm relationship is valuable for
rmsbank loan nancing. One strand of literature emphasizes the importance
of social connections between bank executives and borrowers, since this social
connection enables banks to catalyze the borrowersproprietary and specic
information and reduce banksmonitoring costs (Engelberg et al. 2012; Hasel-
mann et al. 2018). Another strand of literature, with respect to relationship bank-
ing/lending, suggests that banks may invest in costly information production by
building a close relationship over time with borrowers (Boot and Thakor 1994).
Relationship lending allows banks to learn about borrowers more easily at a
lower cost. However, there is mixed evidence regarding whether relationship
lending is benecial for borrowers. Some studies argue that relationship lending
can reduce banksmonitoring costs and benet borrowers with lower nancing
costs (Boot 2000; Behr et al. 2011; Bharath et al. 2011), while other studies pro-
pose the alternative view that relationship lending can lead to rms being locked
in, and that banks may seek more rents due to monopoly power through increas-
ing nancing costs (Sharpe 1990; Rajan 1992; Kano et al. 2011).
In a departure from previous studies, but complementary to them, our focus
is to explore another channel through which the bankrm relationship is
built, namely the bank work experience of rmsexecutives. Through this work
experience, executives have built up their personal relationship with bank man-
agers in that bank and may even extend their relationships to those in other
banks. Recent evidence has suggested that rmsconnections with banks, accu-
mulated through rm executivesbanking experience, are valuable for rms in
terms of applying sophisticated nancial policies (Custodio and Metzger 2014)
and better acquisition decisions (Huang et al. 2014). However, these studies
almost exclusively focus on developed markets and little is known about the
nancial implications of the bankrm relationship in China, whose economy
is known to be relationship based.
Meanwhile, it has also been widely documented that political connections
based on executivesclose connections with governments bring various benets
to rms in accessing nancial resources, such as bank loans and equity issuing,
through rent seeking from government regulations or government lobbying
(Cull and Xu 2005; Claessens et al. 2008; Li et al. 2008; Faccio 2010; Houston
et al. 2014).
Overall, there is a clear connection between the inuence of political con-
nections and the bankrm relationship (we use the term bank connections
hereafter) on bank lending. Thus, we are interested in investigating the relative
impacts of bank connections and political connections on conferring access to
bank loans and explaining how banks make lending decisions. In particular,
this paper intends to answer the question whether and how do bank and
political connections affect bankslending decisions?The answer to this ques-
tion is an essential element in gauging rm value and nancial implications in
a relationship-based economy, and may present a complementary perspective
© 2018 International Review of Finance Ltd. 2018352
International Review of Finance
to existing literature. Following existing studies, we use the sensitivity of the
amount of bank loans to rm protability as the proxy for bank lending deci-
sion. This is because banks have strong incentives to allocate more capital to
nancially healthy rms, thus, reected by a strong sensitivity of bank loan size
to rm protability (Zheng and Zhu 2013).
This paper conducts the research using non-state-owned enterprises (non-
SOEs) in China, because the non-SOE sector in China has provided an ideal
institutional environment in which to address these issues for several reasons,
as explained below.
First, Chinasnancial system and banking industry are largely controlled by
the state, and bank loans are more likely to ow to SOEs than non-SOEs. As a
result, non-SOEs face many obstacles in trying to access external nance to sur-
vive (Firth et al. 2009). Using Chinas non-SOEs as the sample can avoid the
diluted effect of state ownership in SOEs, and allow us to identify the causal
effects of both kinds of connection on rmsnancial policies and bankslend-
ing decisions.
Moreover, there are cross-sectional variations in government supporting poli-
cies across industries, as every 5 years, the government announces a Five Year
Planspecifying that particular industries will be supported by government pol-
icies. There are also cross-sectional variations in institutional environments
across provinces in China (Fan et al. 2011). Thus, the Chinese setting provides
a good environment and creates cross-sectional variations which may shape the
effects of bank connections and political connections on banking nance and
bankslending decisions. Such a cross-regional approach within one country
makes it possible to control for the role of accounting rules, culture, and other
country-level variables (Li et al. 2009). Therefore, an in-depth case study of a
particular countrys experience can provide a useful complement to cross-
country regressions. For all these reasons, our sample facilitates this research
into exploring the nancial implications of bank connections and political con-
nections with respect to rmsbanking nance and bankslending decisions.
We conduct analyses at the bank loan level because there are problems of
identication with rm-level data, since the results could be due to unobserved
heterogeneities in rms which are correlated with bank lending decisions and
connections. Our results show that rms with either bank connections or politi-
cal connections have access to more bank loans. We also nd that bank con-
nections can enhance bankslending decisions by strengthening the positive
relationship between bank loan size and rm protability, while political con-
nections weaken this relationship. Our empirical results further show that the
effect of bank connections is more signicant for rms from less-supported
industries or less-developed regions. By focusing on subsequent performance,
we nd that rms with bank connections perform better over 3-year periods
after the initiation of their bank loans, while those with political connections
perform worse. In addition, we nd that both rm and bank shareholders
highly value bank loans to rms with bank connections, as reected by higher
abnormal returns around bank loan announcements, and discount the value of
© 2018 International Review of Finance Ltd. 2018 353
Bank Work Experience Versus Political Connections

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