Microeconomic effects of bank competition: evidence from corporate financial constraints

【Author】

JIANG Fuxiu;CAI Wenjing;CAI Xinni;LI Xingtian

【Institution】

School of Business, Renmin University of China;School of Business, Renmin University of China;School of Business, Renmin University of China;China Communications Construction Finance Limited

【Abstract】

Bank competition in China has increased dramatically over the last few decades. While the Chinese banking industry in the early 1980s comprised only four commercial banks with separate specializations, both the number and scale of banks in China have grown rapidly since then. Banks now also play an increasing role in China’s economy and the government attaches great importance to them. Specifically, the government encourages banks to help alleviate corporate financial difficulties to serve the development of the real economy. However, no studies have yet examined how bank competition affects the financial constraints faced by most firms, and how these effects vary across different firms. Information asymmetry is an important factor leading to corporate financial constraints (Fazzari et al., 1988; Kaplan and Zingales, 1997). In this paper, we hypothesize that increased bank competition lowers information asymmetry between banks and firms, thus alleviating corporate financial constraints. Banks have to compete with each other for qualified borrowers, especially as bank competition grows fiercer (Huang and Xiong, 2005; Ma et al., 2013). However, a bank that wins customers may run into the “winner’s curse” (Shaffer, 1998). In a highly competitive banking industry, banks with insufficient and asymmetrical information on their customers (such as borrowers) may unintentionally win unqualified customers, and thus lose profit (Broecker, 1990; Rajan, 1992). To prevent this and make the right choice, banks make more efforts to gather and uncover corporate information. Moreover, to earn a profit in a highly competitive banking industry with lower profit margins (Petersen and Rajan, 1995), banks need to gather more information on firms to make more appropriate credit decisions. Hence, bank competition creates strong incentives for banks to gather corporate information, thus reducing the information asymmetry between banks and firms and alleviating corporate financial constraints. To examine our hypothesis that bank competition helps alleviate corporate financial constraints, we first construct a theoretical model to analyze our hypothesis and test it empirically. Using a large sample of commercial banks and all Chinese A-share listed firms from 2000 to 2014, we find that bank competition significantly reduces the cash flow sensitivity of corporate investment, which means that bank competition can reduce corporate financial constraints. These results remain consistent after controlling for endogeneity concerns and substituting an alternative measure for financial constraints. Furthermore, results show that bank competition reduces the costs of corporate debt financing, providing supplementary evidence that bank competition reduces corporate financial constraints. We also find that the effect of bank competition on alleviating corporate financial constraints are greater when firms face more severe information asymmetry. In addition, bank competition reduces the transaction costs of bank loans raised by firms. This paper has made two main contributions to the literature. First, while the literature focuses mainly on how bank competition affects the macro-economy (Berger and Hannan, 1989; Carlin and Mayer, 2003), we provide new evidence on how bank competition influences firms. Although some studies have examined the effect of bank competition on corporate access to finance (Bonaccorsi Di Patti and Dell’ Ariccia, 2004; Chong et al., 2013; Love and Peria, 2014), their conclusions are inconsistent on this issue (Zazutskie, 2006; De Guevara and Maudos, 2011) and do not directly address how bank competition affects corporate financial constraints. Second, we contribute to the literature on financial constraints. From the perspective of funding demands, the literature has mainly studied how corporate characteristics and behaviors affect corporate financial constraints (Custódio and Metzger, 2014; Erel et al., 2015; Deng and Zeng, 2011; Yu et al., 2012). Few studies have examined how financial market development and liberalization may alleviate corporate financial constraints (Love, 2003; Shen et al., 2010), and none has investigated how the banking industry structure influences the corporate financial constraints.

【Keywords】

bank competition;financial constraints;information asymmetry

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