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Government connections and financial constraints : evidence from a large representative sample of Chinese firms

  • Cull, Robert
  • Li, Wei
  • Sun, Bo
  • Xu, Lixin Colin

This paper examines the role of firms'government connections, defined by government intervention in the appointments of Chief Executive Officers and the status of state ownership, in determining the severity of financial constraints faced by Chinese firms. In line with the previous literature, the paper demonstrates that investment by non-state firms is highly sensitive to internal cash flows, while no such sensitivity is found for government-owned enterprises. Even within the subset of non-state firms, government connections are associated with substantially less severe financial constraints (less reliance on internal cash flows to fund investment). The paper also finds that large non-state firms with weak government connections are especially financially constrained, due perhaps to the formidable hold that their state rivals have on financial resources after the"grabbing-the-big-and-letting-go-the-small"privatization program in China. Firms with government-appointed Chief Executive Officers also have significantly lower investment intensities, due perhaps to their lower-powered incentives. The empirical results suggest that government connections play an important role in explaining Chinese firms'investment behavior and financing conditions, and provide further evidence on the nature of the misallocation of credit by China's dominant state-owned banks.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6352.

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Date of creation: 01 Feb 2013
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Handle: RePEc:wbk:wbrwps:6352
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