Abstract

JEL classification

Keywords

۱٫ Introduction

۲٫ Theoretical debates and research hypotheses

۳٫ Sample selection and research design

۴٫ Results and analysis

۵٫ Conclusion

CRediT authorship contribution statement

Appendix A

References

Abstract

This study examines the financing/funding of private firms in China. Our results show that private firms are significantly less funded through formal financing channels such as bank loans than state-owned firms, and hence have to resort to alternative financing such as trade credit. Consistent with the theoretical expectation and literature, there is a substitution effect between trade credit and bank loans for private firms, but this effect is much weaker compared to that of state-owned firms. Moreover, while the univariate comparisons indicate that private firms obtain more notes payable than state-owned firms, the multivariate regression analyses show that the relation between bank loan and notes payable is positive and indifferent between private and state-owned firms.

۱٫ Introduction

The Chinese economy had been dominated by state ownership and central planning before the Chinese economic reform in 1978. After that, the privatization and contracting out of much state-owned industry has remarkably boosted the rapid growth of the private sector which accounted for as much as 70 % of China’s GDP (Engardio, 2005). In the last decade, the private firms, mainly composed of family or individual-owned firms, have become an important force to promote China’s economic growth by expanding employment, promoting technological innovation, and contributing to the government tax revenues (Li et al., 2006; Allen et al., 2005; Tsai, 2002). Despite its fast growth and the increasing importance in the Chinese economy, the private sector encountered many challenges in the due course. One of the biggest challenges is the difficulty in obtaining sufficient financing. Chinese authorities give priority to the financing demand of the state-owned firms by imposing financial constraints on private sectors and ownership discrimination in financial policies. The financial constraints and ownership discrimination make it very difficult for the private firms to be financed by the banking sector which tends to supply most credit resources to the inefficient state-owned companies. Also, the credit rationing in the capital market also limits the sources of funds available to private firms. The ownership discrimination in the capital markets results in the “resource misallocation” that would adversely affect the private firms’ performance and the economic growth in China. Some studies argue that the Chinese capital market provides alternative financing channels and governance mechanisms for private firms. For example, Allen et al., 2005 find that the system of alternative mechanisms and institutions based on reputation and relationships effectively support the growth of the private sector. One stream of literature finds that trade credit might be an important indirect way to provide financing to fast-growing private companies. According to the substitution hypothesis (Meltzer, 1960; Schwartz, 1974; Petersen and Rajan, 1997; Burkart and Ellingsen, 2004; Pattnaik et al., 2020) which is built on the pecking order assumption, because the cost of trade credit can be very high, firms first use relatively inexpensive bank loans and then expensive trade credit after bank loans become unavailable (e.g., Smith, 1987; Petersen and Rajan, 1994). Empirical evidence shows that small U.S. firms that are subjected to bank credit rationing tend to use more trade credit. Hence, trade credit has become one of the most important sources of short-term financing around the world (Rajan and Zingales, 1995; Seifert et al.