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| The Role of Honesty in Public Firms' Bank Loans: Evidence from China |
| DAI Yiyi, ZHANG Pengdong, PAN Yue
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| School of Management, Xiamen University;School of Economy, Xiamen University |
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Abstract Honesty can be considered an important lubricant in business relationships. Although modern institutions are designed to control cheating, in many situations, only intrinsic honesty keeps people from violating rules. A growing body of research on honesty and corporate finance has documented that honesty reduces firms' misconduct and improves their performance, and that firms that cheat in transactions might lose cooperative relationships, and even go bankrupt.
Information asymmetry in economic transactions makes honesty more important, especially in situations such as banks' credit allocation, where firms have full information about their collateral but banks do not. The default risk faced by banks dramatically increases if firms are dishonest, which causes discrimination in banks' credit allocation. This study examines the role of honesty in banks' credit allocation. Specifically, we investigate whether different levels of regional honesty affect bank loans to public firms.
There are two common methods for measuring honesty: surveys and text analysis. However, measurement bias arises in both of these methods. First, respondents are more likely to be honest in surveys. Second, the “honesty” advocated by enterprises can be easily imitated. In this study, we construct a new variable based on the data on deadbeat borrowers (“Laolai” in Chinese) disclosed by the Supreme People's Court of China. We argue that the deadbeat data are less biased than survey and text analysis data for two reasons. First, although survey responses have no cost, the behaviors of deadbeats—that is, refusing to implement court judgments—are real decisions with severe costs. Second, the banks allocating credit are also the main participants in lawsuits against deadbeats, therefore these lawsuits offer insights into regional honesty levels in banking relationships.
We argue that public firms operating in dishonest environments will receive more credit from banks for two reasons. First, all of the firms operating in dishonest environments, public or private, are more likely to act dishonesty due to the low costs. Second, as public firms have more information transparency and external supervision, they can obtain more credit in a dishonest environment.
We test this conjecture using a sample of all of the firms listed on the Shanghai and Shenzhen securities exchanges for the 2003 to 2014 period. The results support our hypothesis, showing that for each 1% decrease in regional honesty level there is a 1.83% increase in public firms' bank loans (over assets). To deal with the endogeneity issues, we control for possible omitted variables related to honesty at the regional level by using two instrument variables: “area of rice plantings in 1978” and “the number of temples within 200 km of public firms.” We construct a PSM-DID model based on firms' relocation events. Our conclusions remain robust.
To provide direct evidence, we further investigate whether the relationship between regional honesty levels and public firms' bank loan varies among firms with different levels of transparency and supervision. We find that the relationship between honesty and credit is strengthened by firms' credibility, measured by higher transparency and more supervision. We also document that the percentage of deadbeats in lawsuits where the plaintiff is a bank strengthens the relationship between regional honesty and firms' loans. However, the effect of regional honesty on firms' bank loan is weaker during an industry crisis and in cities with better social credit systems. We also find that banks react to dishonest environments by shortening the loan maturity and increasing the amount of collateral required.
Our study contributes to the literature in the following ways. First, we examine the role of honesty in the economy. Unlike previous studies of the impact of honesty on firms' behavior and performance, we study the role of honesty in banks' credit allocation. Second, we contribute to the literature on corporate financing. Our study provides new evidence that firms can facilitate their financing by improving information transparency and introducing external supervision, especially private and small enterprises.
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Received: 19 July 2018
Published: 23 August 2019
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