The unintended consequence of local government debt: evidence from stock price crash risk
Introduction
The crash risk of stock prices refers to the risk of a sell-off occurring for a particular stock, causing its stock price to fall suddenly and significantly. Previous studies generally conclude that a lack of information transparency is the main cause of a stock price collapse. For example, Jin and Myers (2006) find that management has the incentive and ability to control the information disclosed by the enterprise: that is, management is motivated to publish positive news and hold back negative news. Other studies have shown that tax avoidance (Kim et al., 2011), political motivation (Piotroski et al., 2015), and accounting conservatism (Kim and Zhang, 2016) may all incentivize management to hide bad news, thus causing enterprise risk to accumulate. Additionally, this information asymmetry leads to a disconnect between the enterprise itself and the market, which causes the overinterpretation of bad news by individual investors (Wen et al., 2019). Once downside news is revealed to investors, it may cause panic selling, causing the stock price to crash. Recent literature has also focused on the impact of religious beliefs (Callen and Fang, 2015), social responsibility (Kim et al., 2014), and top executives’ great famine experience (Cui et al., 2022) on stock price crash risk. This study instead examines the impact of local government debt financing on stock price crash risk based on the stock price data of China A-shares.
Theoretically, the effect of local government debt on stock price crash risk is uncertain because of two different views. One view is that government debt financing has a crowding out effect on enterprise credit (Zhang et al., 2022). With limited financial resources, banks and financial institutions will often prioritize meeting the financing needs of local governments (Huang et al., 2020). They may become more stringent in evaluating the financial information of enterprises and may require them to disclose more information during enterprise loan applications. This improves the quality of information disclosed by the company, thereby reducing the likelihood and magnitude of stock price crash risk. Moreover, Verrecchia (2001) proposes that one way in which enterprises can alleviate financing constraints is by disclosing more information. Consequently, in the face of crowding out caused by government debt, enterprises may be incentivized to actively improve the quality of information disclosed in order to attract investors, which in turn further reduces stock price crash risk.
The other view is that when crowding out presents enterprises with financing constraints, management may also be incentivized to hide bad news and “beautify” financial statements in order to secure external funds (He and Ren, 2022). This may increase the information asymmetry between enterprises and investors, ultimately increasing the crash risk. Additionally, local government debt financing may also cause banks to relax the evaluation of the financial statements of borrowing enterprises. This is because lending a large amount of funds to local governments reduces the nonperforming loan ratio of banks, which may cause banks to relax the verification and screening of information disclosed by enterprises. This may further encourage enterprises to beautify accounting information, increasing the crash risk of stock prices. However, there is limited literature concerning the impact of local government debt on the corporate information disclosure and the economic consequences for the stock market.
The Chinese market is ideal for this study. First, the capital factor market in China is regionally segmented. Due to market access restrictions, it is relatively difficult for private and foreign capital to enter the market, which is one of the reasons why China's financial system is dominated by banks. Second, many commercial banks are openly prohibited from lending credit to foreign enterprises, resulting in local governments and enterprises relying heavily on the local capital market for financing. Third, as China's economy develops further and the Chinese government pushes heavily for infrastructure construction, local governments are tasked with an increasing number of projects, which in turn encourages them to finance their debt using local platforms (Chari et al., 2020). Fourth, China's capital market is not mature, the market is not perfectly regulated, and the information transparency of listed enterprises is generally not high (Li et al., 2019), leading to frequent stock crashes in China. Understanding the motivations behind the efforts of enterprises in disclosing information is also particularly important for Chinese investors and regulators.
Using a sample of Chinese listed companies from 2006 to 2015, this study finds that the effect of local government debt financing can reduce stock price crash risk. After a series of robustness tests, the results remain significant. Further mechanism analysis finds that government debt financing crowds out bank credit, forcing enterprises to improve the quality of information disclosure to obtain credit support. This ultimately leads to a decline in the stock price crash risk. Moreover, the above mitigation effect is more salient for firms located in regions with a low level of marketization and when firms’ financing constraints are high.
The contributions of this study are as follows. First, this study provides new evidence on how information disclosure affects the crash risk of stock prices from the perspective of local government debt financing. The literature mainly explores the causes of stock price crashes from the perspectives of managerial power (Al Mamun et al., 2020), financial information transparency (Kim and Zhang, 2016) and social trust (Li et al., 2017). The current literature overlooks the impact of government debt financing on enterprises at risk of stock price crashes. Second, unlike previous studies that mostly focused on the impact of government debt financing on regional economic growth (Zhao et al., 2019) and corporate financing and investment decisions (Zhang et al., 2022; Fan et al., 2022), this study focuses on the impact of government behavior on the stock market. Third, this study also further examines the differences in the impact of local government debt on stock price crash risk under different market environments and enterprise financing constraints. Moreover, we contribute to the literature concerning the influence of regulation on the crash risk of stock prices. Specifically, previous literature mainly focused on the internal and external supervision, such as auditors (Li et al., 2022), analysts (Kim et al., 2019), and institutional ownership (Fan and Fu, 2020). Our study shows that local government debt financing can enhance the role of bank loan supervision in controlling the crash risk of stock prices, providing a basis for regulators to control the risk of stock price collapse from the perspective of capital chains.
Section snippets
Sample and data
This study uses the data of China A-share listed enterprises between 2006 and 2015. Considering the initial scale of local financing platforms, this study uses 2006 as the starting year. Due to changes in the budget law that took effect in 2015, all data after 2015 is dropped. The data on the existing registered financing platforms of all prefecture-level cities in 2015 is obtained from the China Banking Regulatory Commission (CBRC). The debt information for all corresponding financing
Baseline results
First, Table A1 of the Online Appendix reports the descriptive statistics of the variables. The mean, standard deviation, minimum and maximum of the main variables are consistent with Zhang et al. (2022).
Second, this study examines the impact of local government debt on stock price crash risk. Table 1 presents the baseline regression results of Equation (1). Columns (1) and (2) depict the regression results when including only RET and SIGMA as controls. The coefficients of DEBT are -0.145 and
Robustness tests
This study involves several robustness tests to address potential endogeneity. First, following Chong et al. (2013), this research uses the mean government debt financing of all prefecture-level cities in the same province (excluding the prefecture city in which firm i is located) as the instrument (IV) for government debt financing.
Second, this study performs robustness tests using Equation 1, which excludes all firms in the four municipalities of Beijing, Tianjin, Shanghai, and Chongqing.
Conclusion and discussion
This study first examines the impact of government debt financing on stock price crash risk and finds that the effect of local government debt financing on stock price crash risk is significantly negative. Then, the study examines the economic channels of the effect of government debt financing on stock price crash risk and finds that government debt financing reduces stock price crash risk by improving the information disclosure quality. Finally, the relationship between local government debt
CRediT authorship contribution statement
Shuo Huang: Data curation, Software, Methodology, Formal analysis, Investigation, Writing – review & editing.
Declaration of competing interest
The author declare that there is no conflict of interest.
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