State ownership and banks’ information rents: Evidence from China

• DOI: http://doi.org/10.1111/fire.12197
• Published date: 01 May 2020
• Author: Fengyan Yu,Wei Wang,Qi Liang
• Date: 01 May 2020

DOI: 10.1111/fire.12197

ORIGINAL ARTICLE

State ownership and banks’ information rents:

Evidence from China

Fengy an Yu1Qi Liang2Wei Wang3

1Department of Finance, Tianjin University,

Tianjin, China

2School of Economics, Nankai University,Tianjin,

China

3Department of Finance, ClevelandState

University, Cleveland,Ohio

Correspondence

WeiWang, Department of Finance, Monte Ahuja

Collegeof Business, Cleveland State University,

2121Euclid Ave, Cleveland, OH 44115.

Email:w.wang24@csuohio.edu

Abstract

In a lending relationship, a bank with an information advantage

regarding its client tends to hold up the borrower and charge higher

interest rates. We conjecture that state-owned enterprises (SOEs),

with worse information asymmetry, are subject to greater infor-

mation rents. State-owned banks place less emphasis on informa-

tion production and hence extract lower rents compared to profit-

maximizing private banks. We use the decline of loan interest rates

around the borrowers’ equity initial public offerings (IPOs) as the

proxy of banks’ information rents. We find SOEs in China experi-

ence larger declines in loan interest ratesaround their IPOs; the cen-

tralgovernment-controlled Big Four banks exhibit smaller declines in

rates they charge, and their ratedeclines concentrate on loans made

to SOEs.

KEYWORDS

banking relationship, information rent, IPO, loan interest rate, state

ownership

JEL CLASSIFICATIONS

G21, G24, G32

1INTRODUCTION

The conventional wisdom about lending holds that banks are relationship lenders that acquire proprietary, firm-

specific information about the borrowers through screening and monitoring services to overcome the information

asymmetry (e.g., Allen, 1990; Diamond, 1984). A dark side of banks’ information production is that it creates an

information gap between incumbent banks and outside banks. A firm seeking to switch banks may be perceived by

uninformed outsiders as a “lemon,” regardless of its true financial condition. This gives incumbents monopoly power

to “hold up” the borrowers and charge high interest rates (Rajan, 1992; Sharpe, 1990), especially when the firm lacks

nonbank financing alternatives (Wu, Sercu, & Yao,2009). Recent studies, including Hale and Santos (2009), Schenone

(2010), and Santos and Winton (2008), using loan data in the United States, provide empirical evidence of banks’

information rents.

This paper,focusing on China's banking market where state-owned companies and banks are heavyweight players,

seeks to understand how state ownership influences banks’ rent extraction in such a market.In the same vein as Hale

Financial Review.2020;55:277–305. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 277

278 YU ET AL.

and Santos (2009) and Schenone (2010), we use the borrower firms’ equity initial public offerings (IPOs) as the iden-

tification event to reveal the existenceof pre-IPO rents. IPOs disseminate to the public a large amount of information

about the issuers and, hence, erode incumbent banks’ information advantage, forcing them to lower the loan inter-

est rates. In addition, a firm's equity IPO expands its nonbank financing channels, further dissolving the banks’ holdup

power and the rents they can charge. Thus, the decline in loan interest rates around IPOs can be interpreted as the

evidence of pre-IPO information rents.

We postulate that state ownership could impact the information rents in China's credit marketdue to two features

of state ownership. First, the objective function of state-owned enterprises (SOEs) is not solely profit maximization;

rather, it has a focus on providingsocial services (Baumol, 1984). Bai, Lu, and Tao (2006) contend that SOEs in China

pursue two goals simultaneously: financial profits and social stability. For instance, theytend to avoid firing workers

even infinancial difficulties. This dual-objective problem baffles the efforts to monitor and evaluate SOE performance.

Second, SOEs are owned by the public but controlled by politicians. The public ownership in SOEs is nontransferable,

which “inhibits the capitalization of future consequences into current transfer prices, therefore reducing the incentive

to detect and police managerial behavior” (De Alessi, 1974, p. 646). In addition, politicians have incentivesto suppress

firm-specific information to hide expropriation activities bythem and their cronies (Shleifer & Vishney,1994).

Both the dual objectivesand the separation of ownership (the public) and control (politicians) hinder monitoring and

cause greater information asymmetry in SOEs. Consistent with this, prior research shows that state ownership is asso-

ciated with lower financial reporting quality and financial transparency(Bushman, Piotroski, & Smith, 2004; Guedhami,

Pittman, & Saffar, 2009). In a lending relationship, greater information barriers are more costly for potential compet-

ing banks to overcome, benefiting the incumbents consequently. Thus, we conjecture that SOEs would be subject to

greater information rents in the credit market.

Onthe side of banks, the four largest commercial banks in China,1often dubbed as the Big Four, are controlled by the

central government; in contrast,other commercial banks have widely dispersed ownership structures often without a

controlling owner (see TableA1 in the Appendix). Due to more severe dual-objective and separation of ownership and

control problems than other banks, the Big Four'slending decision making is less likely based on borrowers’ creditwor-

thiness (Berger,Hasan, & Zhou, 2009; Iannotta, Nocera, & Sironi, 2013; Sapienza, 2004). For this reason, the quantity

and quality of proprietary information the Big Fouracquire might be lower, and so would rents they are able to charge.

In summary,we make two hypotheses about the banks’ rent extraction in China's credit market:

H1: Holding all else constant, SOEs are subject to greater informationrents than non-SOE firms.

H2: Holding all else constant, the Big Four banks extractsmaller information rents than non–Big Four banks.

The lending relationships between the Big Four banks and SOEs are especially interesting, as the common politi-

cal and social goals could bring them into the loan transactions. In such SOE–Big Four transactions, impacts of state

ownership on both parties would play a role in determining the cost of loans. On the one hand, the higher information

asymmetry of SOEs impedes them from switching to alternative lenders, suggesting higher bank rents. On the other

hand, the shared political and social goals further diminish the importance of information production, leading to lower

bank rents. The net effect is thus an empirical issue.2

Our investigation is based on a proprietary, loan-level data set that spans the period May1996 through Decem-

ber 2014. The data set contains detailed information of 10,543 traditional loans to private and public firms in China.

In order to detect information rents in a bank–firm relationship, we compare the loan pricing before and after the

1TheAgricultural Bank of China, the China Construction Bank, the Bank of China, and the Industrial and Commercial Bank of China combined held about half

ofthe industry assets during 2003–2012 and made 60% of loans in our sample.

2As an anonymous reviewer points out, additional factors to consider include governmentintervention and political connections. “Policy lending” between

the Big Fourand SOEs abounded in 1980s and early 1990s wherebybanks served as an intermediary to channel funds from the Central Bank to SOEs (Wei

& Wang,1997). The Big Four–SOE lockup greatly loosened since 1990s as banks became more market-oriented (Cull & Xu, 2003). Thus in our sample period

(1996–2014), government intervention is relatively less relevant. Khwaja and Mian (2005), however,argue that political connections would still facilitate

lending from the Big Fourto SOEs. Anecdotes run that sometimes managers of SOEs faced political pressure to borrow from only the Big Four, or vice versa.

Theimplication of political connections on the holdup problem, however, is again ambiguous as the pressure can be on either party.