We study how shadow banking affects the effectiveness of monetary policy in China.Using novel data on bank-issued off-balance sheet wealth management products (WMPs), we show that banks improve their on-balance sheet risk profile by issuing WMPs. This in turn lowers the sensitivity of banks' wholesale funding cost to monetary policy and reduces the effectiveness of the bank lending channel. The effect of our mechanism on total credit is quantitatively similar to the effect arising from the substitution between traditional loans and shadow banking loans previously analyzed in the literature. The channel documented in this paper has novel implications for the regulation of banks' off-balance sheet activities and market-based funding.

We provide firm-level evidence on the real effects of shadow banking in terms of technological innovation. Firm-to-firm entrusted loans, the largest part of the shadow banking sector in China, enhance the borrowers’ innovation output. The effects are more prominent when the borrowers are subject to severer financial constraints, information asymmetry, and takeover exposures. A plausible underlying channel is capital reallocations from less productive but easy-financed lender firms to more innovative but financially less-privileged borrower firms. Our paper suggests shadow banking helps correct bank credit misallocations and thus serves as a second-best market design in financing the real economy

China’s shadow banking system has experienced surprisingly high growth since the global financial crisis. We develop a model to understand this puzzling phenomenon. With local government interventions in bank loans for low-quality projects and information asymmetry between banks and regulators, a policy combination of tightening formal banking and loosening shadow banking can reduce inefficiency, because the higher funding liquidity risk of shadow banking incentivizes banks to be more disciplined about the quality of projects. We find consistent empirical evidence that when on-balance-sheet financing was constrained by regulators, banks primarily shifted high-quality projects into their controlled shadow banking system.

We study the demand for government participation in China’s venture capital and private equity market. We conduct a large-scale, non-deceptive field experiment in collaboration with the leading industry service provider, through which we survey both sides of the market: the capital investors and the private firms managing the invested capital by deploying it to high-growth entrepreneurs. Our respondents together account for nearly $1 trillion in assets under management. Each respondent evaluates synthetic profiles of potential investment partners, whose characteristics we randomize, under the real-stakes incentive that they will be introduced to real partners matching their preferences. Our main result is that the average firm dislikes investors with government ties, indicating that the benefits of political connections are small compared to the cons of having the government as an investor. We show that such dislike is not present with government-owned firms, and this dislike is highest with best-performing firms. Additional results and follow-up surveys suggest political interference in decision-making is the leading mechanism why government capital is unattractive to private firms. We feed our experimental estimates and administrative data into a simple model of two-sided search to discuss the distributional effects of government participation. Overall, our findings point to a “grabbing hand” interpretation of state-firm relationships reflecting a desire by the government to keep control over the private sector.

There is little empirical work examining contractual innovation in the context of China, which is the second largest venture capital market in the world, after the United States. Drawing upon extensive interviews, a hand-collected dataset of investment agreements and judgements made by Chinese courts on venture capital disputes, this article examines a unique contractual design that is common in the Chinese venture capital sector—the valuation adjustment mechanism (“VAM”). A VAM provides investors with a right to adjust a portfolio company’s original valuation and to get compensation by cash or equity upon the occurrence of certain future events (such as failing to meet financial or non-financial performance indicators). The prevalence of VAMs in China is potentially attributable to: (1) severe information asymmetry in the less informed market, (2) the lack of convertible preferred stock under Chinese law and excessive legal restrictions over investment tools and contractual mechanisms in venture capital financing, and (3) insufficient legal protection for investors under Chinese law. This article argues that, unlike American venture capital contracts, which are designed to encourage long-term, sustainable investor-entrepreneur relationships, VAMs are predominantly investors’ self-help mechanisms to address specific and serious investor protection issues in the transitional and less informed Chinese market. Thus, it suggests that the problems regarding investor protection motivating the use of VAMs can be better solved by law reforms such as allowing limited liability companies to issue convertible preferred stock, introducing more legal remedies for minority investors, as well as an improved regulatory environment governing venture financing.

Prior studies have demonstrated that market timing is an important factor in determining firm investments and financing policies. We provide empirical evidence on the effects of market timing on equity-based compensation and stock dividend decisions. To avoid endogeneity, we exploit the setting of overvaluation resulting from the 2015 Chinese government’s open-market purchases of common stocks of public firms. We test whether the over-valued firms cater to managers’ and investors’ preferences of not receiving over-valued shares. Consistent with this catering hypotheses, we find that firms purchased by the government are less likely to issue equity-based compensation and stock dividends after government’s stock market intervention relative to other firms whose shares were not purchased by the government. These results are more pronounced when the over-valuation is likely driven by retail investors.

What are the benefits to a firm of having investors with gambling preference as shareholders? Motivated by studies showing that gambling investors prefer lottery-like stocks and require lower expected returns to take risk, we hypothesize that firms with positively-skewed assets can use stock splits to attract investors with gambling preference to share risk and to lower cost of equity. Indeed, analyzing a sample of Chinese firms that split their stocks through stock dividends and using proprietary trading data to measure retail investors’ gambling preference, we find that, on average, shareholders increase by 54% and retail gambling investors increase by 119% following stock dividends. Furthermore, while firms become more risk-taking, their cost of equity declines substantially, largely due to the increased retail gambling investors’ pricing influence. Thus, stock splits are effective for improving risk-sharing efficiency, and gambling investors contribute to lowering the cost of capital.

This paper documents a stock-dividend premium of around 10% when controlling for optimistic earnings growth and liquidity improvement. We propose an alternative explanation for the effect of stock dividends from the perspective of investor recognition. First, we find that stock-dividend premiums are positively related to an increase in investor base, particularly for firms with a small investor base. Second, an increase in investor base is due to individual investors, as they, especially those with a stronger propensity to gamble, are net buyers around the announcement of stock dividends, while institutional investors behave in the opposite manner. Finally, we show that after paying stock dividends, firms experience significant increases in speculative features, which are caused by clientele shifts toward individual investors as opposed to the undertaking of riskier projects by managers. As a whole, our results also indicate that an increase in investor base could be related to investors’ gambling preferences.

Using a large sample of over 5,000 start-ups across various industries and 524 media outlets in China between 2000 and 2016, we examine the effects of media coverage of start-ups on VC investment decisions and performance. To the best of our knowledge, for the first time in the finance literature, we have discovered that media coverage of start-ups significantly affects VC investment decisions and exit performance. Specifically, such coverage, especially positive coverage, significantly increases the probability and amount of VC investments in start-ups. It also significantly improves the exit performance of VC investments. The significant effects of media coverage of start-ups on VC investments are driven by market-oriented instead of state-controlled media. We further find that VC investments in a focal start-up are significantly influenced by the average media coverage of other start-ups in the same industry or the same city. Our results are robust to a battery of robustness tests. Our research contributes to the behavioral finance literature by showing that an increasingly prominent type of institutional investors, venture capitalists, just like individual investors, are also subject to limited attention. Our research also extends the research by You, Zhang and Zhang (2018) by revealing the heterogeneous effects of market-oriented and state-controlled media on VC investments. Last but not the least, we are the first to discover that peer start-ups’ media coverage matters for VC investments in the focal firms, thereby pushing the frontier of research on the roles of media in finance.

This paper examines the effects of Chinese venture capital (VC)’s final exit on their portfolio companies. We find that, compared to other early investors, VCs achieve significantly higher returns from their exit of the portfolio companies. We use the presence of VC directors and the introduction of high-speed rail to address identification concerns. Announcements manipulation and earnings management are plausible channels through which VCs achieve higher returns when they exit from the companies. VCs’ exit negatively influences their portfolio companies’ long-term performance. Our paper sheds new light on the value creation role played by VCs and discovers a previously ignored adverse effect of VCs – the exploitation of their portfolio companies.