Effect of severe litigation and bank connection on bank financing in China

Abstract

Abstract We empirically examine the effect of severe litigation, bank connection and their interaction on firms’ access to bank financing based on China’s background. We find that (i) firms with a recent history of severe litigation experience a decrease in bank financing regardless of whether they are defendants or plaintiffs; (ii) firms with bank connections obtain more bank financing; and (iii) bank connection can mitigate the detrimental impact of severe litigation on bank financing. Our findings suggest that banks recognise the high costs and risks of severe litigation to firms, thus imposing more financing constraints on firms with severe litigation. Meanwhile, bank connection can help firms recover from the detrimental impact of severe litigation, corroborating the argument that informal mechanisms, such as those based on social relations, promote financial transactions and thus the growth of firms in China.