Do Financial Frictions Explain Chinese Firms' Saving and Misallocation?

Working Paper: NBER ID: w24436

Authors: Yan Bai; Dan Lu; Xu Tian

Abstract: We use firm-level data to identify financial frictions in China and explore the extent to which they can explain firms' saving and capital misallocation. We first document the features of the data in terms of firm dynamics and debt financing. State-owned firms have higher leverage and pay much lower interest rates than non-SOEs. Among privately owned firms, smaller firms have lower leverage, face higher interest rates, and operate with a higher marginal product of capital. We then develop a heterogeneous-firm model with two types of financial frictions, default risk, and a fixed cost of issuing loans. Our model generates endogenous borrowing constraints as banks consider the firm's productivity, asset, and debt when providing a loan. Using evidence on the firm size distribution and financing patterns, we estimate the model and find it can explain aggregate firms' saving and investment and around 50 percent of the dispersion in the marginal product of capital within private firms, which translates into a TFP loss as high as 12%.

Keywords: financial frictions; capital misallocation; Chinese firms; saving behavior

JEL Codes: E21; G32

Causal Claims

Cause	Effect
financial frictions (G19)	capital misallocation (E22)
capital misallocation (E22)	loss in total factor productivity (TFP) (O49)
financial frictions (G19)	investment decisions of firms (G31)
financial frictions (G19)	saving behavior (D14)
smaller firms (L25)	higher MPK (E12)
state-owned enterprises (SOEs) (L32)	higher leverage (G32)
state-owned enterprises (SOEs) (L32)	lower interest rates (E43)
correlation between saving rates and investment rates (E22)	financial frictions (G19)
financial frictions (G19)	distortion of investment decisions of less productive firms (H32)
capital adjustment costs (G31)	investment decisions of more productive firms (D25)