Utilizing the removal of the bank lending interest rate floor (IRFD) in China as an exogenous shock of banking liberalization, we find that IRFD leads to a significant rise in firms’ cost of equity capital, which is consistent with the prediction from the MM theory. The identified effects are more pronounced among firms with weaker ex-ante corporate governance and more severe ex-ante agency problems. We also find that IRFD witnesses an increase in the amount of acquired bank loans, a decrease in the average interest rate, and an increase in free cash flow. Further evidence also suggests IRFD provokes a drop in firms’ investment quality. Overall, our findings highlight an unexplored role of banking sector deregulation on firms’ cost of equity capital.

The finance–growth nexus has been a central question in understanding the unprecedented success of the Chinese economy. With unique data on all the registered firms in China, we build extensive ownership networks, reflecting firm-to-firm equity investment relationships, and show that thesenetworks have been expanding rapidly since the 2000s, with more than five million firms in at least one network by 2017. Entering a network and increasing network centrality, both globally and locally, are associated with higher firm growth. Such positive network effects tend to be more pronounced for high productivity and privately owned firms. The RMB 4 trillion stimulus, mostly in the form of newly issued bank loans and launched by the Chinese government in November 2008 in response to the global financial crisis, partially ‘crowded out’ the positive network effects. Our analysis suggests that equity ownership networks and bank credit tend to act as substitutes for state-owned enterprises, but as complements for privately owned firms in promoting growth.

This study examines relation between financial development and the cost of equity capital and finds the following main results: (1) stock market development in general reduces cost of equity, consistent with its role in liquidity provision, information asymmetry reduction, and risk diversification helping to reduce systemic risk; (2) banking development only weakly decreases the cost of equity, consistent with the pervasive state-ownership in large banks constraining their efficiency. Further analysis reveals that the relation between stock market development and cost of equity is more pronounced in large firms and in firms with lower growth potentials, suggesting that stock market development fails to support small and/or growth firms. Moreover, the relation is more pronounced in region with low accounting quality, weak law enforcement, or lower market integration, and in period prior to split share structure reform. The evidence suggests that stock market developments and other institutional arrangements substitute each other in reducing cost of equity. This study contributes to literatures on financial development and cost of equity, and also holds immediate policy implications.

We develop a model of a financial institution to study how shareholder—debt holder conflicts interact with prudential capital regulation and accounting measurement rules. Our analysis highlights the result that, for highly leveraged financial institutions—when prudential regulation play an important role—debt overhang and asset substitution inefficiencies work in opposing directions. We demonstrate that, relative to the “historical cost” regime in which assets and liabilities on an institution’s balance sheet are measured at their origination values, fair value could alleviate the inefficiencies arising from asset substitution, but exacerbate those arising from underinvestment due to debt overhang. The optimal choices of accounting regime and prudential solvency constraint balance the conflicts between shareholders and debt holders. Under fair value accounting, the optimal solvency constraint declines with the institution’s marginal cost of investment in project quality and the excess cost of equity capital relative to debt capital. Fair value accounting dominates historical cost accounting provided the solvency constraints in the respective regimes take their optimal values. If the solvency constraints are sub-optimally chosen, however, historical cost accounting could dominate fair value accounting.

In this paper, we examine the cost of equity capital for politically connected firms. After controlling for several firm- and country-level determinants, our results show that politically connected firms have a lower cost of equity capital than their nonconnected peers. Our results are robust to alternative measures and proxies for the cost of equity capital. We thus provide strong evidence that investors require a lower cost of capital for politically connected firms, suggesting that these firms are generally considered to be less risky than non-connected firms. Our findings imply that the benefits of political connections outweigh their costs. We conjecture that this perception is fueled by the soft budget constraints generally enjoyed by politically connected firms, and by their lower default probability, given the assurance of corporate bailout in the event of financial downturns.

This paper provides evidence on the significant impact of illiquidity or non-marketability on security valuation. A typical listed company in China has several types of share outstanding: (i) common shares that are only tradable on stock exchanges, (ii) restricted institutional shares (RIS) that are not tradable and can only be transferred privately or through irregularly scheduled auctions, and (iii) state shares that are only transferable privately. These types of share are identical in every aspect, except that market regulations make state and RIS shares almost totally illiquid. Our analysis focuses on the price differences between RIS and common shares of the same company, using both auction and private-transfer transactions for RIS shares. Among our findings, the average discount for RIS shares relative to their floating counterpart is 77.93% and 85.59%, respectively based on auction and private transfers. The price for illiquidity is thus high, significantly raising the cost of equity capital. This illiquidity discount increases with both the floating shares’ volatility and the firm’s debt/equity ratio, but decreases with firm size, return on equity, and book/price and earnings/price ratios (based on the floating share price). However, RIS share price can either increase or decrease with the quantity being transacted, depending on whether it is through a private placement or an auction.

Stock market liberalization is a decision to allow foreign investors to purchase domestic shares. This paper is an event study on market reactions around the announcement of the Qualified Foreign Institutional Investors (QFII) scheme in China. We find no significant abnormal returns in market indices in the short-term period leading up to the announcement, negative abnormal returns in the short-term period following the announcement, and no significant abnormal returns in the long-term period thereafter. The findings do not comply with the prediction of international asset pricing models. The QFII scheme may not help much in reducing the cost of equity capital and risk premium of China companies.