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

• Author: Xiaofei Pan,Gary Gang Tian
• DOI: http://doi.org/10.1111/irfi.12225
• Published date: 01 June 2020
• Date: 01 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-

utives’connections 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 find that bank loans are more closely related to profitabil-

ity for firms with bank connections, while firms’political connections

weaken this relationship. We further find that the influence of bank connec-

tions is more significant for firms from less supported industries or less devel-

oped regions. Furthermore, firms with bank connections are less likely to

become financially distressed after the initiation of their bank loans and

experience higher future stock returns, while firms with political connections

experience the opposite outcome. Overall, our results indicate that in the

context of a relationship-based economy like China, firms’connections with

banks create value by alleviating information asymmetry and improving

banks’lending 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 10–13, 2013; the Asian Finance Association

Annual Meeting, Nanchang, July 15–17, 2013; the World Finance & Banking Symposium, Beijing,

December 16–17, 2013; and the 2014 CICF in Chengdu, China, on July 10–13, 2014.

© 2018 International Review of Finance Ltd. 2018

International Review of Finance, 20:2, 2020: pp. 351–382

DOI: 10.1111/irfi.12225

I. INTRODUCTION

Recent literature has documented that the bank–firm relationship is valuable for

firms’bank loan financing. One strand of literature emphasizes the importance

of social connections between bank executives and borrowers, since this social

connection enables banks to catalyze the borrowers’proprietary and specific

information and reduce banks’monitoring 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 beneficial for borrowers. Some studies argue that relationship lending

can reduce banks’monitoring costs and benefit borrowers with lower financing

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 firms being locked

in, and that banks may seek more rents due to monopoly power through increas-

ing financing 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 bank–firm relationship is

built, namely the bank work experience of firms’executives. 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 firms’connections with banks, accu-

mulated through firm executives’banking experience, are valuable for firms in

terms of applying sophisticated financial 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

financial implications of the bank–firm relationship in China, whose economy

is known to be relationship based.

Meanwhile, it has also been widely documented that political connections

based on executives’close connections with governments bring various benefits

to firms in accessing financial 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 influence of political con-

nections and the bank–firm 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 banks’lending decisions?”The answer to this ques-

tion is an essential element in gauging firm value and financial 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 firm profitability as the proxy for bank lending deci-

sion. This is because banks have strong incentives to allocate more capital to

financially healthy firms, thus, reflected by a strong sensitivity of bank loan size

to firm profitability (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, China’sfinancial system and banking industry are largely controlled by

the state, and bank loans are more likely to flow to SOEs than non-SOEs. As a

result, non-SOEs face many obstacles in trying to access external finance to sur-

vive (Firth et al. 2009). Using China’s 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 firms’financial policies and banks’lend-

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

Plan”specifying 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 finance and

banks’lending 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 country’s experience can provide a useful complement to cross-

country regressions. For all these reasons, our sample facilitates this research

into exploring the financial implications of bank connections and political con-

nections with respect to firms’banking finance and banks’lending decisions.

We conduct analyses at the bank loan level because there are problems of

identification with firm-level data, since the results could be due to unobserved

heterogeneities in firms which are correlated with bank lending decisions and

connections. Our results show that firms with either bank connections or politi-

cal connections have access to more bank loans. We also find that bank con-

nections can enhance banks’lending decisions by strengthening the positive

relationship between bank loan size and firm profitability, while political con-

nections weaken this relationship. Our empirical results further show that the

effect of bank connections is more significant for firms from less-supported

industries or less-developed regions. By focusing on subsequent performance,

we find that firms 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 find that both firm and bank shareholders

highly value bank loans to firms with bank connections, as reflected 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