Skip to main content
SpringerLink
Log in

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

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

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.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

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

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

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

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

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

References

  • Aharony J, Wang J, Yuan H (2010) Tunneling as an incentive for earnings management during the IPO process in China. J Acc Pub Pol 29:1–26

    Article  Google Scholar 

  • Allen F, Qian J, Qian M (2005) Law, finance, and economic growth in China. J Financ Econ 77:57–116

    Article  Google Scholar 

  • An Z (2012) Taxation and capital structure: empirical evidence from a quasi-experiment in China. J Corp Financ 18:683–689

    Article  Google Scholar 

  • Bae K, Kang J, Kim J (2002) Tunneling or value added? Evidence from mergers by Korean business groups. J Financ 57:2695–2740

    Article  Google Scholar 

  • Berger A, Hasan I, Zhou M (2009) Bank ownership and efficiency in China: what will happen in the world’s largest nation? J Bank Financ 33:113–130

    Article  Google Scholar 

  • Berkman H, Cole RA, Fu LJ (2009) Expropriation through loan guarantees to related parties: evidence from China. J Bank Financ 33:141–156

    Article  Google Scholar 

  • Berkman H, Cole RA, Fu LJ (2010) Political connections and minority-shareholder protection: evidence from securities-market regulation in China. J Financ Quant Anal 45:1391–1417

    Article  Google Scholar 

  • Bertrand M, Mehta P, Mullainathan S (2002) Ferreting out tunneling: an application to Indian Business Groups. Q J Econ 117:121–148

    Article  Google Scholar 

  • Buchuk D, Larrain B, Muñoz F, Urzúa IF (2014) The internal capital markets of business groups: evidence from intra-group loans. J Financ Econ 112:190–212

    Article  Google Scholar 

  • Cheng S (2009) An analysis of China’s stock market in the first 10 years. Rev Pac Basin Financ Mark Policies 12(04):629

    Article  Google Scholar 

  • Claessens S, Djankov S, Fan J, Lang L (2002) Disentangling the incentive and entrenchment effects of large shareholdings. J Financ 57:2741–2771

    Article  Google Scholar 

  • Defond M, Wong T, Li S (1999) The impact of improved auditor independence on audit market concentration in China. J Acc Econ 28:269–305

    Article  Google Scholar 

  • Ding S, Jia C, Wilson C, Wu Z (2014) Political connections and agency conflicts: the roles of owner and manager political influence on executive compensation. Rev Quant Financ Acc. doi:10.1007/s11156-014-0441-9

    Google Scholar 

  • Faccio M, Lang HP, Young L (2010) Pyramiding vs leverage in corporate groups: international evidence. J Int Bus Stud 41:88–104

    Article  Google Scholar 

  • Firth M, Fung PMY, Rui OM (2006) Corporate performance and CEO compensation in China. J Corp Financ 12:693–714

    Article  Google Scholar 

  • Firth M, Lin C, Liu P, Wong S (2009) Inside the black box: bank credit allocation in China’s private sector. J Bank Financ 33:1144–1155

    Article  Google Scholar 

  • García-Herrero A, Gavilá S, Santabárbara D (2009) What explains the low profitability of Chinese banks? J Bank Financ 33:2080–2092

    Article  Google Scholar 

  • He J, Mao X, Rui OM, Zha X (2013) Business groups in China. J Corp Financ 22:166–192

    Article  Google Scholar 

  • Hou W, Moore G (2010) Player and referee roles held jointly: the effect of state ownership on China’s regulatory enforcement against fraud. J Bus Ethics 95:317–335

    Article  Google Scholar 

  • Huang Y (2003) One country, two systems: foreign-invested enterprises and domestic firms in China. China Econ Rev 14:404–416

    Article  Google Scholar 

  • Huang W (2015) Tunneling through intercorporate loans: quasi-experimental evidence from China. Working paper

  • Huyghebaert N, Wang L (2012) Expropriation of minority investors in Chinese listed firms: the role of internal and external corporate governance mechanisms. Corp Gov Int Rev 20:308–332

    Article  Google Scholar 

  • Jian M, Wong T (2010) Propping through related party transactions. Rev Acc Stud 15:70–105

    Article  Google Scholar 

  • Jiang G, Lee C, Yue H (2010) Tunneling through inter-corporate loans: the China experience. J Financ Econ 98:1–20

    Article  Google Scholar 

  • Joh S (2003) Corporate governance and firm profitability: evidence from Korea before the crisis. J Financ Econ 68:287–322

    Article  Google Scholar 

  • Johnson S, La Porta R, Lopez-de-Silanes F, Shleifer A (2000) Tunneling. Am Econ Rev Pap Proc XC:22–27

    Article  Google Scholar 

  • Klapper L, Love I (2004) Corporate governance, investor protection and performance in emerging markets. J Corp Financ 10:703–728

    Article  Google Scholar 

  • La Porta R, Lopez-de-Silanes F, Shleifer A, Vishny R (2002) Investor protection and corporate valuation. J Financ 57:1147–1170

    Article  Google Scholar 

  • Leuz C (2010) Do foreigners invest less in poorly governed firms? Rev Financ Stud 23:3245–3285

    Article  Google Scholar 

  • Lin BX, Lu R, Zhang T (2012) Tax-induced earnings management in emerging markets: evidence from China. J Am Tax Ass 34:19–44

    Article  Google Scholar 

  • Lins K (2003) Equity ownership and firm value in emerging markets. J Financ Quant Anal 38:159–184

    Article  Google Scholar 

  • Liu Q, Lu Z (2007) Corporate governance and earnings management in the Chinese listed companies: a tunneling perspective. J Corp Financ 13:881–906

    Article  Google Scholar 

  • Liu Q, Tian G (2012) Controlling shareholder, expropriations and firm’s leverage decision: evidence from Chinese non-tradable share reform. J Corp Financ 18:782–803

    Article  Google Scholar 

  • Lo AWY, Wong RMK (2011) An empirical study on voluntary transfer pricing disclosures in China. J Acc Pub Pol 30:607–628

    Article  Google Scholar 

  • Lo AWY, Wong RMK, Firth M (2010) Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. J Corp Financ 16:225–235

    Article  Google Scholar 

  • Ni J, Kwak W, Cheng X, Gong G (2014) The determinants of bankruptcy for Chinese firms. Rev Pac Basin Financ Mark Pol 17(2):1450012

    Article  Google Scholar 

  • Peng WQ, Wei KCJ, Yang Z (2011) Tunneling or propping: evidence form connected transactions in China. J Corp Financ 17:306–325

    Article  Google Scholar 

  • Qian M, Yeung B (2014) Bank financing and corporate governance. J Corp Financ. doi:10.1016/j.jcorpfin.2014.10.006

    Google Scholar 

  • Shan YG (2013) Can internal governance mechanisms prevent asset appropriation? Examination of type I tunneling in China. Corp Gov Int Rev 21:225–241

    Article  Google Scholar 

  • Shevlin T, Tang T, Wilson R (2012) Domestic income shifting by Chinese listed firms. J Am Tax Ass 34:1–29

    Article  Google Scholar 

  • Sun Q, Tong WHS (2003) China share issue privatization: the extent of its success. J Financ Econ 70:183–222

    Article  Google Scholar 

  • Tong WHS, Yu WW (2012) A corporate governance explanation of the A-B share discount in China. J Int Mon Financ 31:125–147

    Article  Google Scholar 

  • Tung S, Cho S (2001) Determinants of regional investment decisions in China: an econometric model of tax incentive Policy. Rev Quant Financ Acc 17:167–185

    Article  Google Scholar 

  • Wang K, Xiao X (2011) Controlling shareholders’ tunneling and executive compensation: evidence from China. J Acc Pub Pol 30:89–100

    Article  Google Scholar 

  • Wu L, Yue H (2009) Corporate tax, capital structure, and the accessibility of bank loans: evidence from China. J Bank Financ 33:30–38

    Article  Google Scholar 

  • Xu W, Zeng Y, Zhang J (2011) Tax enforcement as a corporate governance mechanism: empirical evidence from China. Corp Gov Int Rev 19:25–40

    Article  Google Scholar 

  • Zhang Z (2007) Legal deterrence: the foundation of corporate governance—evidence from China. Corp Gov Int Rev 15:741–767

    Article  Google Scholar 

  • Zhang J, Wang P, Qu B (2010) Bank risk taking, efficiency, and law enforcement: evidence from Chinese city commercial banks. China Econ Rev 23:284–295

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Nottingham University Business School China, 199 Taikang East Road, Ningbo, 315100, China

    Wei Huang

Authors
  1. Wei Huang
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Wei Huang.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

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

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-015-0523-3

Keywords

JEL Classification

Search

Navigation