1. 1 Property Rights Protection and Access to Bank Loans: Evidence from Private Enterprises in China Chong-En Bai (Tsinghua University) Jiangyong Lu (Tsinghua University) Zhigang Tao (The University of Hong Kong)

2. 2 Motivation Private sector development is important (Perotti, 2004; McMillan and Woodruff, 2002, for transition economies). External financing is important for private sector development –entrepreneurial firms –efficient allocation of capital (Levine, 1997) –transition economies (Johnson, McMillan and Woodruff, 2002; Cull and Xu, 2005) Bank financing Property rights protection is important for private firm to obtain bank credit.

3. 3 Poor Protection of Private Property in China It was only in the 1988 amendment of the Constitution of the People ’ s Republic of China that private sector development was permitted and considered to be supplementary to the working of the Socialist economy. The role of private sector development was further elevated to being important to the Socialist market economy in the 1999 amendment of the Constitution. Finally, in the 2004 amendment of the Constitution, private sector development was called for, and formal protection of private property was offered. Recent controversy about the property rights protection law.

4. 4 Poor Protection of Private Property in China Private property, when poorly protected, is subject to expropriation by various parties in the society and particularly by government officials (Bai, Li, Qian, and Wang, 2004). –local government officials may impose informal levies on private enterprises, –they may even extort bribes for personal gains, –private firms are at disadvantage in contract disputes. Banks are reluctant to extend credit to private firms because the poor protection of the latter ’ s property rights.

5. 5 Informal Substitutes of Private Property Rights Protection Political participation Philanthropic activities The Main Hypothesis: Private enterprises whose owners have more political participation or which conduct more philanthropic activities face less difficulty in getting access to bank loans.

6. 6 Political participation by private enterprises Reasons for entrepreneurs to join the partyPercentage Business development40.9 Social status18.3 Political protection13.6 Communist ideal13.6 Belief in Chinese Communist Party9.1 Becoming part of the healthy force in the party4.5 Source: "Development report of China's private enterprises," 2002, p. 67

7. 7 Data for Empirical Testing Survey of private enterprises in China conducted in 2000 jointly by –the United Front Work Department of the Central Committee of the Communist Party of China, –the All China Industry and Commerce Federation, –the China Society of Private Economy at CASS. Multi-stage stratified random sampling.

8. 8 Data for Empirical Testing The survey covered 3,073 private enterprises – about 0.2 percent of the total private enterprises in China at the end of 1999 – with representation in –all 31 regions and –all economy sectors (excluding the sector of government, parties and social organizations).

9. 9 Data for Empirical Testing The survey questions were answered by the owners of the private enterprises. Personal information of entrepreneurs, and also information about the private enterprises. Difficulty in Access to Bank Loan: The degree of difficulty for them to obtain bank loan using a scale between 1 and 5

10. 10 Bank Loans to Private Enterprises Degree of difficultySample size Very easy70 Relatively easy314 Varies from time to time570 Relatively difficult834 Very difficult790 Total2578

11. 11 Political Participation and Philanthropic Activities CPC Member: member of the People ’ s Congress CPPCC Member: member of the Chinese People ’ s Political Consultative Conference Donation: the logarithm of the amount of donations the enterprise has made throughout its history.

12. 12 Control Variables Control 1: It is more difficult for private enterprises to get bank loans if they face greater risk of expropriation (such as firms paying higher informal levies and/or facing more serious corruption problems). Informal Levy: whether a private enterprise has paid any informal levies Corruption: whether a entrepreneur thinks it is necessary to apply stricter anti-corruption policies than the existing ones

13. 13 Control Variables Control 2: It is more difficult for private enterprises to get bank loans if they encounter more or severer discriminatory restrictions in business operations. Discrimination: whether private enterprises are treated differently from their state-owned or foreign invested counterparts in 12 aspects of business operation (excluding external borrowing) Regression with or without control 1 and control 2

14. 14 Control Variables Control 3 (appraisal): (i) Access to bank loans is easier for private enterprises that are rated by independent credit rating agencies. (ii) Among private enterprises that are rated by independent credit rating agencies, those with higher credit ratings are expected to have easier access to bank loans (To control for the self-selection bias).

15. 15 Control Variables Control 4 (signaling): (i) Access to bank loans is easier for private enterprises that adopt higher-quality financial and management control systems. (ii) Access to bank loans is easier for private enterprises that have larger size of operation, or are managed by entrepreneurs with more years of managerial experience, or have higher capital labor ratios, or enjoy higher return on assets.

16. 16 Potential Endogeneity Problems Successful business operation in the past can create the opportunity of political participation by private entrepreneurs and increase the capacity for philanthropic activities of private enterprises. At the same time, successful business operation in the past could also make it easy for private enterprises to convince bankers and secure bank loans. Control 4 (ii) is about the past performance of private enterprises (such as the size of operation, years of managerial experience, and return on assets), and it mitigates the endogeneity problem in the main hypothesis to some extent.

17. 17 Control Variables Control 5 (screening): Access to bank loans is easier for private enterprises that are located in smaller cities or counties and for those located in regions with higher percentages of non-state-owned financial institutions. Percentage of Loans by Non-State Banks: the percentage of loans issued by non-state-owned banks in a region in 1999. (Non-state banks screen better.) Located in Small City: whether a private enterprise is located in a small city or county as opposed to a large or medium city. (Within each region, non-state banks are more likely located in small cities.)

18. 18 Summary Statistics VariablesMinMaxMeanStd. Difficulty in Access to Bank Loan 153.771.1 CPC Member 010.160.4 CCPCC Member 010.40.5 Donation 016.129.483.5 Informal Levy 010.390.5 Corruption 010.560.5 Discrimination 0125.073.9

19. 19 Summary Statistics Independent Credit Rating 010.240.4 High on Credit Rating 010.950.2 Internal Control 010.850.4 Size of Establishment 09.94.071.3 Managerial Experience 03.822.250.7 Capital Labor Ratio 0.771290.38.1433 ROA 0.00070.840.210.2 Percentage of Loans by Non-State Banks 0.0460.320.210.1 Located in Small City 010.580.5

20. 20 Regressions about Difficulty in Access to Bank Loan (Ordered Logistic Regression) Independent Variables without any control with controls 1&2, without other controls without controls 1&2, with other controls with all the controls CPC Member-0.39***-0.441***-0.13**-0.222* CCPCC Member-0.05 0.044 0.02 0.165 Donation-0.06***-0.053***-0.028*-0.025

21. 21 Results Membership in the People ’ s Congress reduces the degree of difficulty in obtaining bank loans. Membership in the Chinese People ’ s Political Consultative Conference does not have a significant effect. Philanthropic activities help. Similar results hold with OLS regressions.

22. 22 Results The effects of informal levy and corruption are all significant; the risk of expropriation makes it more difficult for private enterprises to obtain bank loans. The effect of discrimination is significant. Size, capital labor ratio, and being located in small cities have significant effects.

23. 23 Conclusion In the face of poor protection of private property rights, private enterprises can improve their access to bank loans through political participation and philanthropic activities. Informal substitutes for formal protection are useful. The risk of expropriation and discrimination have significant negative effects on the access to bank loans by private enterprises. The evidence is also consistent with other conventional theories on the access to bank loans.