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Relationship-Based Resource Allocations: Evidence from the Use of “Guanxi” during SEOs

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Abstract

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.

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[Brockman, Paul] Lehigh Univ, Bethlehem, PA USA [Firth, Michael; He, Xianjie] Shanghai Univ Finance & Econ, Shanghai, Peoples R China

[Mao, Xinyang] Shanghai Lixin Univ Accounting & Finance, Shanghai, Peoples R China

[Rui, Oliver] CEIBS, Shanghai, Peoples R China


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Source

Journal of Financial and Quantitative Analysis

ISSN:0022-1090

Year:2019

Issue:3

Volume:54

Page:1193-1230

ESI Discipline:ECONOMICS & BUSINESS;

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