July 1, 2022

Dear EFA Member,

As a current or recent EFA member, we are pleased to forward you the contents of the recently published second issue of Volume 26 of the Review of Finance – the EFA’s own journal – along with digests (short summaries) and abstracts.


Zhiguo He, Yongxiang Wang

China may soon become the world’s largest economy, but most academic research in top journals is based on USA and European data. The insights from these papers with western perspectives may not necessarily apply to China, given its unique set of institutional features. At the same time, many aspects of the Chinese economy are shared by other developing as well as developed countries, such as potential conflicts of interest between majority and minority shareholders, the prevalence of state ownership, and the intricate interactions between market mechanisms and policy interventions. Therefore, the insights from “China” papers, which typically take advantage of unique institutional settings in China, could be of great value to countries far beyond China, independent of whether the research is aimed at certain general economic questions or explores China-specific economic and social issues.

The Review of Finance, thanks to the initiative and support of managing editor Alex Edmans, launched a Special Issue on China in 2020. We are honored to serve as editors for this special issue, which covers all aspects of financial economics in China, including asset pricing, capital markets, financial intermediation, and corporate finance. Among more than 200 submissions, we aimed to publish papers that meet the following ordered criteria: (a) papers that are high-quality academic work; (b) papers that inform readers about the first-order issues of contemporary Chinese financial markets; and (c) papers that highlight interesting institutional features with clear connections to questions about which western readers care.

The first Special Issue on China includes eight excellent papers that aced the above criteria. We received so many high-quality submissions that satisfied the three criteria that we will publish a second Special Issue on China, likely in 2023 as some papers are still in the final stages of the editorial process. We look forward to introducing those papers then.

Below we present the digests for the current issue. The full introduction can be found here.

Zhiguo He and Yongxiang Wang


Authors: Bo Li, Jacopo Ponticelli

Using a new case-level dataset, we document a set of stylized facts on bankruptcy in China and study how the staggered introduction of specialized courts across Chinese cities affected insolvency resolution and the local economy. For identification, we compare bankruptcy cases handled by specialized versus traditional civil courts within the same city and filed in the same year. We find that specialized courts decrease case duration by 36% relative to traditional civil courts. We provide evidence consistent with court specialization increasing efficiency via selection of better trained judges and higher judicial independence from local politicians. We document that cities introducing specialized courts experience a relative reallocation of employment out of zombie firms-intensive sectors, as well as faster firm entry and a larger increase in average capital productivity.


Authors: Sumit Agarwal, Yongheng Deng, Quanlin Gu, Jia He, Wenlan Qian, Yuan Ren

Many countries have witnessed a tremendous increase in house prices fuelled by mortgage debt accumulation, which in turn imposes a substantial financial burden on households. For example, servicing mortgage debts typically consume as much as 35% of mortgagors’ household disposable income in China. Although rich in housing assets, mortgagors are generally poor in cash and thus exhibit a significant marginal propensity to consume (MPC). The heavy mortgage debt burden is likely to have significant implications for monetary policy transmission when mortgage-servicing costs adjust with the interest rate.

In the paper “Mortgage Debt, Hand-to-Mouth Households, and Monetary Policy Transmission”, Sumit Agarwal, Yongheng Deng, Quanlin Gu, Jia He, Wenlan Qian, Yuan Ren show that the positive disposable income shocks induced by an interest rate cut significantly boosted mortgagors’ consumption. The authors exploit China’s expansionary monetary policy shocks announced in September 2008, which automatically reduced the mortgage rate by 230bps for the population of mortgagors in China starting from January 2009. Using a representative sample of credit card holders from a leading Chinese commercial bank, the authors show that mortgagors increased their monthly credit card spending by 8.7% after the policy announcement, compared with outright homeowners. The credit card delinquency rate also decreased by 1.7% (40bps).

The cash-on-hand constraint is an important mechanism underlying their findings. Constrained mortgagors experienced a more pronounced spending response, and their spending did not increase until the mortgage rate reset. The researchers also confirm that their findings are unexplained by the wealth or intertemporal substitution channel, the contemporaneous fiscal stimulus package, or a more favorable credit expansion to mortgagors after the policy shock.

Collectively, the effect of the debt-service channel is significant—the researchers’ estimate implies an MPC of 0.40-0.54 through credit card spending. With the rise of the middle class, China’s mortgage debt outstanding grew exponentially during the past decade, equivalent to 34% of the GDP by the end of 2020. It implies that the debt-service channel is playing an increasingly important role in transmitting monetary policies in China.


Authors: Joseph D Piotroski, T J Wong, Tianyu Zhang

In this article, we examine whether comovement in the stock prices of pairs of Chinese firms connected to the same political network are systematically shaped by the prevailing coordination versus competition incentives of that network’s politicians. We find strong evidence from 2000 to 2012 (Jiang’s and Hu’s regimes) that stock price comovement is affected by the embeddedness of the firm–politician ties within the network. Among pairs of firms connected to a network through a common politician, we document an increase in stock price comovement. For those pairs of firms connected to a common network via separate politicians (rather than a common politician), we document a relative decrease in stock price comovement. This negative effect suggests that politicians’ relationships within these political networks are generally adversarial rather than cooperative in nature. These results become significantly weaker during Xi’s regime from 2013 to 2017, suggesting that Xi’s anti-corruption campaign and state-owned enterprise reforms may have attenuated these political network effects on the firms. Our additional tests also show that stock price comovement becomes even more positive (negative) in settings which are expected to increase the coordination or decrease the competition (decrease the coordination or increase the competition) of the politicians.


Authors: Lei Jiang, Jinyu Liu, Lin Peng, Baolian Wang

In this paper, Jiang, Liu, Peng, and Wang investigate the relationship between investor attention and financial market anomalies. They study 17 widely studied anomalies and find that anomaly returns tend to be higher following high-attention days. The result is robust after controlling for the effect of news and in a natural experiment setting in which a stock market regulation and rounding errors generate exogenous variations in attention. An analysis of order imbalances suggests that large traders trade on anomaly signals more aggressively upon observing higher attention. They discuss the extent to which the findings are driven by inattention-driven underreaction, bias amplification, or coordinated arbitrage mechanisms, thereby providing insight into the understanding of anomalies. Their study makes several contributions. First, they contribute to the recent literature on the common drivers of anomalies. Second, they also document that the majority of the anomalies studied in the US hold in the Chinese data, providing out-of-sample evidence.


Authors: Xuan Tian, Jiajie Xu

Technological innovation and entrepreneurial activities are key drivers of a nation’s economic growth. Intensive studies have explored a variety of economic, institutional, and social determinants that could promote innovation and entrepreneurial activities. Specifically, public policies, such as various government subsidiary programs, government-sponsored venture capital (VC), research and development (R&D) tax credit programs, and federal spending, have played important roles and attracted many discussions from researchers and regulators. A fast-growing class of “place-based” policies, however, receives relatively little attention from financial economists although researchers have discovered significant effects of geography on corporate finance decisions and stock market performance. In this paper, we focus on an emerging country, China, and studies the effectiveness of place-based policies by examining how the establishment of national high-tech zones, a prominent place-based public policy in China, affects local innovation output and entrepreneurial activities.

China presents an ideal setting for carrying out research on place-based policies, in particular on national high-tech zones: In 1988, the Ministry of Science and Technology of China (MOST) implemented the “Torch Plan” with the main goal of establishing national high-tech zones. The policy aimed to develop China’s high-tech industries and enhance economic growth. The first national high-tech zone, the ZhongGuan Village (Beijing) high-tech zone, was established in 1988. In 1990, the State Council approved the first wave of 20 national high-tech zones. After the early success, in 1991, the State Council promulgated preferential policies for national high-tech zones and approved the second wave of 26 high-tech zones. In 1992, the third wave of 25 high-tech zones was approved. By the end of 2016, there had been 146 national high-tech zones established in China across all provinces and autonomous regions.

To tackle the endogeneity issue and establish causality, we use a difference-in-differences (DiD) approach that uses staggered establishments of national high-tech zones in various Chinese cities during our sample period. Our baseline DiD regressions suggest that the establishment of national high-tech zones has a positive, causal effect on local innovation output and entrepreneurial activities. Specifically, compared to cities without high-tech zones established, cities with high-tech zones exhibit a 36.9% larger increase in patent applications, a 50.3% larger increase in patent grants, a 17.5% larger increase in patent citations, and a 12.9% larger increase in new firm registrations. These effects are economically sizable and support the argument that China’s place-based policies spur local innovation output and entrepreneurial activities. A number of additional tests suggest that the effects appear causal.

Furthermore, we show that access to finance, reductions in administrative burden, and talent cultivation and introduction could be three plausible underlying channels through which high-tech zones promote local innovation and entrepreneurship. Lastly, national high-tech zones appear to have some positive spillover effects on nearby cities instead of increasing their own innovation output and entrepreneurial activities at the cost of nearby cities.

Our paper sheds new light on the evaluation of the effectiveness of China’s place-based policies in terms of promoting local innovation and entrepreneurship.


Authors: Hong Ru, Kunru Zou

Privatization has been one of the most important economic reforms since 1980 across the globe (e.g., Mexico, Central Europe, Soviet Union) and is ongoing as the central political and economic policy in many countries. For example, in China, the second-largest economy worldwide, state-owned enterprises (SOEs) still play a vital role, especially in strategic industries.

This paper examines the Politics-Economics nexus in privatization implementations and outcomes in China. In particular, we document that local politicians play an essential role in the privatization of local SOEs. When local politicians are connected to top political leaders (patrons) in the Central Committee of the Communist Party of China, they are more likely to sell SOEs to corrupt buyers at substantially discounted prices (i.e., value loss of state-owned assets), indicating rent-seeking activities in privatization process. Moreover, the subsequent performance of these privatized SOEs under the local politicians with patronage connections is significantly worse. Furthermore, we find that corruption underlies the adverse effects of patronage connections on privatization outcomes. Specifically, privatized SOEs engage in significantly more fraudulent and corrupt activities after privatization when they have corrupt buyers as new owners. Consequently, these SOEs have efficiency losses following privatization.

To identify such adverse effects of patronage connections, we employ the fuzzy regression discontinuity (RD) approach by using the mandatory retirement age cut-offs for Central Committee members to explore the discontinuities in local politicians' connections and privatization outcomes. Every five years, the terms of all Central Committee members end, and members who are at or past the mandatory retirement age at that time are ineligible to renew their terms. The age limits for term renewals of minister-level and national-level Central Committee members are 64 and 68, respectively. This mandatory retirement rule was strictly enforced without a single exception during our sample period.

The figure below plots efficiency gains two years before and after privatization (i.e., ∆TFP_2, ∆ROA_2, and ∆OROA_2) against the distance between connected ages of senior politicians in Central Committee and their retirement age cut-offs (point zero on the horizontal axis). We find significant jumps in ∆TFP_2, ∆ROA_2, and ∆OROA_2 following privatization at the cut-offs when the local politician's connected Central Committee members step down due to mandatory retirement.

In summary, we identify the patronage’s adverse effects on efficiency gains of privatization in China and show an essential mechanism: patronage connections induce local politicians to sell SOE shares to corrupt buyers, who increase the newly privatized entity’s corrupt activities.

The vertical axis represents SOE efficiency changes, and the horizontal axis represents distance, which equals the connected Central Committee’s ages minus the mandatory retirement ages (i.e., 64 for minister-level politicians and 68 for national-level politicians). 95% confidence intervals are drawn around the linear best fit.


Authors: Zijia Du, Alan Guoming Huang, Russ Wermers, Wenfeng Wu

We use Word2vec to develop a financial sentiment dictionary from 3.1 million Chinese-language financial news articles. Our dictionary maps semantically similar words to a subset of human-expert generated financial sentiment words. In validation tests, our dictionary scores the sentiment of articles consistently with human reading of full articles. In return association tests, our dictionary outperforms and subsumes previous Chinese financial sentiment dictionaries, such as direct translations of Loughran and McDonald’s (2011, Journal of Finance, 66, 35–65) English-language financial dictionary. We also generate a list of politically related positive words that is unique to China; we find that this list has a weaker association with returns than does the list of other positive words. We demonstrate that state media uses more politically related positive and fewer negative words, and exhibits a sentiment bias. This bias renders the state media’s sentiment as less return-informative. Our findings demonstrate that dictionary-based sentiment analysis exhibits strong language and domain specificity.


Authors: Jeffery (Jinfan) Chang, Ting Yang, Yanping Shi

Shadow banking involves credit intermediation activities outside the traditional banking system. In contrast to the United States and Europe, where shadow banking activities have been under ever-increasing scrutiny since the 2008 subprime mortgage crisis, China has witnessed tremendous shadow banking growth since that crisis.

This paper investigates an important yet still understudied constituent of China’s shadow banking system: finance leases. By analyzing a hand-collected transaction-level dataset on the finance leases of China’s public firms for the period 2007-2019, this paper sheds light on China’s leasing market, the second largest in the world. We find that banks use their affiliated leasing firms to provide credit to clients in order to circumvent the government’s targeted credit policy. In contrast to conventional views of regulatory arbitrage, our evidence indicates that, instead of hiding risk and gambling for profit, banks mainly use their affiliated leasing firms to support high-quality clients. The bank affiliated institutions can play a strategic role in relationship banking. We find several pieces of evidence in support of this hypothesis.

First, bank-affiliated leases charge lower leasing rates than non-bank-affiliated leases. Second, the realized credit risk of bank-affiliated leases is lower than that of non-bank-affiliated leases. Third, we find that the leasing rates of bank-affiliated leases are more efficient in terms of reflecting the credit risk of the lessee than those of non-bank-affiliated leases. Fourth, the bond issuance yield of bank-affiliated financial leasing firms is, on average, 70–80 bps lower than that of non-bank-affiliated firms after controlling for bond and issuer characteristics, implying the existence of implicit guarantees from parent banks. Finally, we find positive stock market response to the bank-affiliated lease announcement (but not to the non-bank-affiliated lease).

All these findings suggest that the function of shadow banking is much more intricate than simply just hiding risk as many expected. The market force could still be working, although in an unexpected fashion, inside the shadow banking system. Based on our findings, policy makers may want to have a careful examination of the economic mechanism behind each type of shadow banking activities and be cautious about making regulation policies to weigh in the pros and cons of shadow banking.



NOTE: This and previous issues of Review of Finance [ISSN 1572-3097 | EISSN 1573-692X] are freely available to current EFA members as a benefit of annual membership.  For information on how to submit a manuscript to Review of Finance, please visit the RF Editorial Office website revfin.org.  Follow us on LinkedIn.

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