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| Does Reform of the Security Interests System Reduce the Cost of Corporate Debt？ Evidence from a Natural Experiment in China |
| QIAN Xuesong, TANG Yinglun, FANG Sheng
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School of Economics, Huazhong University of Science and Technology;
International School of Business & Finance, Sun Yat-Sen University |
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Abstract China's economic development has always been plagued by the difficulty and high cost of corporate financing. To improve the financing environment for firms, the government of China has promoted market-oriented financial reforms, adjusted the structure of direct financing and indirect financing, and encouraged the development of small and medium-sized banks. However, issues related to corporate financing remain unresolved. According to a survey conducted by the All-China Federation of Industry and Commerce in 2017, the cost of financing is still the most important cost factor affecting the development of firms. To address this issue, the importance of supply-side structural reform and measures to reduce firm costs were emphasized at the 19th National Congress of the Communist Party of China. In addition, a 2019 government work report included making corporate financing easier and less costly as a key task. Thus, the question of how to reduce the cost of corporate financing has drawn the attention of policymakers, entrepreneurs, and researchers. Particularly in light of China's constantly changing legal system, one important problem is how the cost of corporate debt responds to the reform of the security interests system, which is exogenously induced by the enactment of the Property Law.
As China has transitioned from a planned economy to a market economy, new laws have been continuously introduced to improve the legal environment of the market economy. Compared with previous laws, the Property Law enacted in 2007 introduced a broader and more efficient system of security interests and reduced the transaction costs of secured lending transactions. In particular, the menu of assets legally accepted as collateral was enlarged to include accounts receivable, inventories, and other liquid assets. The reform of the security interests system induced by the Property Law has reduced the risk of secured lending transactions and helped enhance the bargaining power of borrowing firms; this is expected to affect the cost of corporate debt. Thus, this provides an ideal setting for us to study how legal reforms affect the cost of corporate debt financing.
Using the Property Law's enactment as a natural experiment and a difference-in-differences method, we construct a sample of manufacturing firms based on the Annual Survey of Industrial Firms in China during 2003-2008 and study the effect of the law on the cost of corporate debt. We find that the reform leads to a significant reduction in the cost of debt, and this effect is more pronounced for firms with a lower proportion of fixed assets. Furthermore, consistent with the economic intuition that the Property Law reduces the cost of debt financing by expanding the range of collateralized assets, triple-difference tests indicate that the reduction effect shows rich diversity. First, the reform more strongly reduces the cost of corporate debt in provinces with less developed legal or financial environments. Second, the reform more strongly reduces the cost of debt for firms subject to severe financial constraints.
Researchers have not reached a consensus on the determinants of the cost of corporate debt. In particular, although many empirical studies using cross-sectional data find that legal systems are an important determinant, few studies explore whether and how legal reforms in an emerging and transitional economy like China's affect the cost of corporate debt. This paper not only identifies the causal relationship between creditor protection-strengthening legal reforms and a declining cost of corporate debt but also clearly reveals that reform of the security interests system reduces the cost of corporate debt by strengthening creditor protections and enhancing the bargaining power of borrowing firms. This paper provides fresh empirical evidence from China's emerging and transitional economy for the law and finance literatures, and it improves our understanding of how creditor protections influence the cost of debt.
In addition, this paper has important policy implications. To alleviate the difficulty and high expense of corporate financing, we must continuously promote the benign change of the basic financial system through market-oriented legal reforms and consolidate the basic institution of the capital market.
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Published: 23 July 2019
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