In the paper Bank Loans with Chinese Characteristics: Some Evidence on Inside Debt in a State-Controlled Banking System, forthcoming in the Journal of Financial and Quantitative Analysis, we study the process of bank lending to corporations in a transitional environment. A simple model of a pooling equilibrium suggests that both negative and positive announcement effects are possible, depending on whether the banking system is run on purely commercial terms or is subject to political goals. Empirical results are based on a sample of large loans from Chinese banks to listed Chinese borrowers. We find that poorly performing firms are more likely to receive bank loans, and these loans appear intended to keep troubled firms afloat as subsequent long-run performance is typically poor. Stock values for Chinese borrowers typically decline significantly around bank loan announcements. Furthermore, these negative announcement effects are heightened for borrowers with frequent related-party transactions, poor subsequent performance, high state ownership, no foreign class shares, loans from local bank branches, or loans intended to repay existing debt. Thus, the Chinese stock market appears to understand corporate performance and what these loans mean, and responds accordingly, in contrast to the widely-held perception that it is inefficient.

(more…)