Journal of Financial and Quantitative Analysis
We examine the role of relationship-based resource allocations during the approval process of secondary equity offerings (SEOs) in the Chinese capital market. In this unique regulatory setting, SEO-seeking firms must have their applications approved by an Issuance Examination Committee (IEC) of the China Securities Regulatory Commission (CSRC), a hybrid template between government-directed and market-directed models. We identify guanxi-based relationships as cases in which the partner of an intermediary professional firm (e.g., auditing or law) employed by the SEO applicant also serves on secondment as a full-time IEC member. Our results show that these guanxi-based relationships significantly increase the likelihood of SEO approvals, particularly for suspect SEO applicants with abnormal levels of earnings management, related-party transactions, and inter-company loans. More importantly, we find that guanxi-influenced SEO firms have significantly poorer performance in the post-SEO period, which indicates that it results in inefficient resource allocations. In addition, we show that these quid pro quo arrangements benefit IEC-member intermediaries through higher market shares and professional fee revenues. Overall, our evidence suggests that relationship-based resource allocations lead to negative spillover effects that impose social welfare losses.
We investigate whether business groups in China act as internal capital markets, in an environment that is characterized by a high level of government intervention, a weak legal system, and an underdeveloped financial market. We study how institutional factors, such as the ultimate owner and level of market development, shape the role of these business groups. We find that business groups help member firms overcome constraints in raising external capital, and that the internal capital market within a business group is more likely to be an alternative financing channel among state-owned firms than among private firms. We also find that the internal capital market is more likely to help those affiliated firms which are private, local government owned relative to those owned by central government, or located in regions with a well-developed institutional environment. We present evidence of the role of business groups in risk sharing among affiliated firms, but find that business group affiliation has no impact on firm accounting performance. This study sheds new light on the theory of the firm and its boundaries, and provides a better understanding of China's rapidly growing economy.