We study financial market contracts and signals in a transitional economy where state-controlled banks may lend to weak firms to avert unemployment and social instability. Our sample of Chinese corporate borrowers reveals that that poorer financial performance and higher managerial expenses increase the likelihood of obtaining a bank loan, and bank loan approval predicts poor subsequent borrower performance. Furthermore, negative event-study responses are observed at bank loan announcements, particularly if the borrower measures poorly on quality and creditworthiness. Our results document the dilemmas that arise in a state-led financial system and the local stock market’s sophistication in interpreting news.