10 1016@j Jbankfin 2014 06 011

Journal of Banking & Finance 48 (2014) 276291
Contents lists available at ScienceDirect
Journal of Banking & Finance

journal homepage: www.elsevier.com/locate/jbf
State ownership, soft-budget constraints, and cash holdings: Evidence

from Chinas privatized rms q
William L. Megginson a,b,, Barkat Ullah c,1, Zuobao Wei c,2
a
Price College of Business, The University of Oklahoma, 307 West Brooks, 205A Adams Hall, Norman, OK 73019-4005, United States
King Fahd University of Petroleum & Minerals, Dhahran, Saudi Arabia
c
College of Business Administration, University of Texas at El Paso, El Paso, TX 79968, United States
b
a r t i c l e
i n f o
Article history:
Received 22 June 2013
Accepted 13 June 2014
Available online 8 July 2014
JEL classication:
G32
G34
G38
Keywords:
Privatization
State ownership
Soft-budget constraints
Cash holdings
China
a b s t r a c t
We study the relation between state ownership and cash holdings in Chinas share-issue privatized rms from
2000 to 2012. We nd that the level of cash holdings increases as state ownership declines. For the average
rm in our sample, a 10 percentage-point decline in state ownership leads to an increase of about RMB 55 million in cash holdings. This negative relation can be attributable to the soft-budget constraint (SBC) inherent in
state ownership. The Chinese nancial system is dominated by the state-owned banks, an environment very
conducive for the SBC effect. We further examine and quantify the effect of state ownership on the value of
cash and nd that the marginal value of cash increases as state ownership declines. The next RMB added to
cash reserves of the average rm is valued at RMB 0.96 by the market. The marginal value of cash in rms with
zero state ownership is RMB 0.36 higher than in rms with majority state ownership. The SBC effect exacerbates
agency problems inherent in state-controlled enterprises, contributing to their lower value of cash.
2014 Elsevier B.V. All rights reserved.
1. Introduction
The efcient management of liquidity is essential to the success
of any business. Over the past decade or so, nancial economists
have devoted much attention to the causes and consequences of
the large and increasing amount of liquid assets on corporate balance sheets around the world. Scholars have developed various
explanations for the cross-section, cross-country, and time-series
variations in corporate cash holdings. These explanations encompass
q
We thank Jarrad Harford, Ivalina Kalcheva, Sifei Li, Karl Lins, Chen Liu, Yixin Liu,
Yu Liu, Neslihan Ozkan, Meijun Qian, Alejandro Riano, Valerity Sibilkov, and Feixue
Xie for helpful comments and suggestions. This study has also beneted from
comments offered by participants in the 2013 ECCE-USB Financial Globalization
and Sustainable Finance conference at the Stellenbosch Business School, Cape
Town, South Africa and the 2012 Financial Management Association meeting in
Atlanta, Georgia. Finally, we appreciate the nancial support afforded to this project
by the University of Oklahomas Price College of Business and George Lynn Cross
Research Professorship, the KFUPM Chair Professor in Finance, and the University of
Texas at El Pasos College of Business Administration.
Corresponding author at: Price College of Business, The University of Oklahoma,
307 West Brooks, 205A Adams Hall, Norman, OK 73019-4005, United States. Tel.: +1
(405) 325 2058; fax: +1 (405) 325 7688.
E-mail addresses: wmegginson@ou.edu (W.L. Megginson), sbullah@utep.edu
(B. Ullah), zwei@utep.edu (Z. Wei).
1
Tel.: +1 (915) 400 8478.
2
Tel.: +1 (915) 747 5381.
http://dx.doi.org/10.1016/j.jbankn.2014.06.011
0378-4266/ 2014 Elsevier B.V. All rights reserved.
motives for holding cash, the need to overcome nancial constraints,

agency conicts between various corporate stakeholders, and country level institutional and market development.3 In this paper, we
employ a well-established theory in economics, the soft-budget constraint (SBC) theory, to study the relation between state ownership
and cash holdings in Chinas share-issue privatized (SIP) rms.
SIP rms are an important group of publicly traded rms that
has received limited attention so far in the growing body of literature on corporate cash holdings.4 SIP rms differ from other publicly traded rms (those which were de novo private) in one very
3
See Kim et al. (1998), Harford (1999), Opler et al. (1999), Dittmar et al. (2003),
Almeida et al. (2004), Ozkan and Ozkan (2004), Pinkowitz et al. (2006), Faulkender
and Wang (2006), Dittmar and Mahrt-Smith (2007), Kalcheva and Lins (2007),
Harford et al. (2008), Bates et al. (2009), Liu and Mauer (2011), and many others.
4
Over the past four decades, governments around the world have undertaken massive
privatization programs (Megginson and Netter, 2001; Megginson, 2005; Bortolotti and
Megginson, 2012). The cumulative proceeds raised by privatizing governments since
1977 now exceed $2.5 trillion. Privatization has taken place in developed and developing
economies and across all political persuasions. Many governments chose share-issue
privatizations (SIPs), as opposed to direct asset sales. Measured by the amount of
proceeds raised, SIPs are by far the largest share offerings in history. The share-issue
privatization of Chinas state-owned Industrial and Commercial Bank of China (ICBC) in
2006 raised a staggering US$ 22 billion (McGuiness and Keasey 2010). The biggest IPO of
all time by a U.S. company, the November 2010 IPO of General Motors after it emerged
from bankruptcy, was also a privatization in that the federal government sold roughly
half of the stake it acquired in GM in the 2008 rescue.
W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291
important aspect: the privatizing governments usually continue to

wield substantial inuence or control in the SIP rms through
retained equity ownership. In the case of China, most of the publicly
traded companies are former state-owned enterprises (SOEs) that
were privatized through share offerings starting in the early 1990s.
The Chinese government retains an average (median) of 21.4%
(5.7%) equity ownership in our sample rms.5
The retained state ownership in Chinas SIP rms provides an
excellent setting to examine the SBC effect on corporate cash
holdings. State ownership has long been linked to inefciency
and underperformance (Shleifer and Vishny, 1994; Boycko et al.,
1996; Megginson and Netter, 2001). A major cause of this inefciency is that state ownership is more likely than private ownership to suffer from the soft-budget constraint (SBC) effect rst
formulated by Kornai (1979, 1980). In a nutshell, an organization
with a soft budget constraint can always count on a supporting
organization (such as the government) to bail it out when its budget constraint is persistently breached. The SBC theory suggests
that state ownership is inherently linked to the SBC effect. Therefore, we employ state ownership as the proxy for the SBC effect in
our study: the higher the state ownership the more severe the
SBC effect. We further argue that the SBC effect can manifest
itself in Chinas SIP rms through two channels: (1) the relation
between the level of cash holdings and state ownership, and (2)
the relation between the marginal value of cash and state
ownership.
Chinas nancial system is dominated by state-owned banks
(Allen et al., 2005). The combination of the dominating stateowned banks and the retained state ownership in Chinas SIP
rms provide fertile ground for the SBC effect to take hold. Lin
and Tan (1999) and Cull and Xu (2000, 2003) document that SOEs
in China have better access to credit in state-owned banks and
can expect to receive nancial help in times of distress. Hence,
we argue that a rm with a high state ownership does not need
to hold high level of cash since credit will be readily available
from state-owned banks, even if the company becomes nancially
distressed and loses access to external private funding. Therefore,
we hypothesize that cash holdings and state ownership are negatively related.
High state ownership leads to soft budget constraints, which in
turn lead to more agency problems. Agency theory suggests that
those who control the rm exploit corporate resources to further
their own interests (Jensen 1986). One type of resources, liquid
assets, provides a particularly attractive opportunity for managers
to expropriate, since liquid assets are readily accessible by managers and do not attract much scrutiny from capital markets or other
outside stakeholders. Managers who operate under a SBC have
more opportunities to appropriate corporate assets, especially
liquid assets. These managers may also be more susceptible to corruption and pressure to invest in politically expedient projects,
rather than NPV maximizing projects. Several recent studies show
that high agency costs are associated with low marginal values of
cash (Pinkowitz et al., 2006; Dittmar and Mahrt-Smith, 2007;
Kalcheva and Lins, 2007; Liu and Mauer, 2011). Therefore, we
hypothesize a negative relation between state ownership and the
marginal value of cash in Chinas SIP rms.
5
Other privatizing governments also retain ownership in SIP rms, as documented
by the Jones et al. (1999) study of share-issue privatization programs in 59 countries,
which nds evidence of continued political interventions after the rst privatizing
share sales. The governments in their sample sell an average (median) of 43.9%
(35.0%) of the SOEs capital in initial offers and 22.7% (18.1%) in subsequent seasoned
issues, suggesting that the governments retain signicant equity ownership in the
privatized rms. Though these governments often surrender day-to-day management
of the rm post-privatization, they can retain inuence and control over major
corporate decisions, such as top personnel appointments, mergers and acquisitions,
and foreign takeovers.
277
We choose to study the SBC effect, as proxied by state ownership, on corporate cash holdings in Chinas SIP rms for several reasons. First, there is a wide cross-sectional variation of state
ownership in Chinas SIP rms, ranging from zero to over 90% in
our sample rms. This wide variation allows us to examine the
degree of the SBC effect on the level of cash holdings, as well as
on the marginal value of cash. Second, cash holdings in Chinas
publicly traded rms are large and increasing. At the end of
2012, the total amount of liquid assets held by Chinas publicly
traded non-nancial rms in our sample was approximately RMB
2.95 trillion (about US$ 469 billion).6 Fig. 1 illustrates the mean cash
holdings and state ownership over our sample period 20002012.
Fig. 1 shows dramatic decreases in state ownership over the sample
period, from a mean of 34.7% in 2000 to 4.3% in 2012. In contrast, the
cash ratio increases signicantly over the same time period, from a
mean of 18.7% in 2000 to 32.8% in 2012. 7 Fig. 1 illustrates an overall
negative relation between state ownership and cash holdings. Third,
as pointed out earlier, Chinas SIP rms operate in a nancial system
dominated by state-owned banks. Such an environment is very conducive to the SBC effect (Lin and Tan, 1999). However, scholars thus
far have paid little attention to the causes and consequences of cash
holdings in Chinas listed sector, even though China has the worlds
second largest economy and one of the largest stock markets (Allen
et al., 2005). In this regard, our study contributes to the cash holding
literature by providing the rst comprehensive empirical evidence
from China.
We rst examine the relation between state ownership and
cash holdings. We nd that state ownership and cash holdings
are negatively related, consistent with our hypothesis that high
state ownership leads to SBC, and therefore less need to hold high
levels of cash. For the average rm in our sample, a 10 percentagepoint decline in state ownership leads to an increase of about RMB
55 million in cash holdings. This nding is robust to a battery of
robustness checks, including year effects, rm xed effects, and
controlling for Chinas split share structure reform and the potential endogeneity between state ownership and cash holdings. We
further nd that smaller, more protable, and high growth rms
hold more cash, and that debt and net working capital are negatively related to cash holdings, consistent with ndings in U.S.
and other international rms.
In the second part of this paper, we examine the effect of state
ownership on the marginal value of cash, and nd that the
marginal value of cash increases as state ownership declines. For
the average rm in our sample, the next RMB of cash added to its
cash reserves is valued at RMB 0.96, whereas the next RMB of cash
is valued RMB 0.36 higher in rms with zero state ownership than
in rms with majority state ownership. As the government reduces
its stake in the SIP rms, access to credit in state-owned banks
becomes harder, so the budget constraint hardens. Firms with hard
budget constraints invest their funds more efciently and receive
higher returns, leading to higher marginal values of cash (Kornai,
2001; Denis and Sibilkov, 2010).
The rest of the paper is organized as follows. Section 2 provides
a brief discussion of the SBC theory and a snapshot of the Chinese
nancial system. Section 3 describes our data and sample, while
Section 4 studies the relation between state ownership and the
level of cash holdings. Section 5 examines the effect of state ownership on the marginal value of cash, while Section 6 presents
conclusions.
6
Liquid assets (or cash reserves) include cash and marketable securities at the end
of 2012 across all non-nancial rms in our database. The Chinese currency is called
renminbi (peoples money), or RMB. The exchange rate at the end of 2012 was RMB
6.2896/US$ (IMF International Financial Statistics).
7
The cash ratio is dened as cash reserves over total book assets minus cash
reserves (i.e. noncash assets).
278
0.40
0.35
0.30
0.25
0.20
0.15
Mean cash holdings
0.10
Mean state ownership
0.05
0.00
1999
2001
2003
2005
2007
2009
2011
2013
Year
Fig. 1. State ownership and cash holdings in China, 20002012. Cash holdings is cash ratio, measured as cash and cash equivalents divided by net assets. Net assets is dened
as total book assets minus cash and cash equivalents. State ownership is the fraction of total shares owned by the state and managed by Chinas State Assets Management
Authority (SAMA).
2. Soft-budget constraint theory and the Chinese nancial

system
2.1. The soft-budget constraint theory8
Jnos Kornai observed in the 1970s that the chronic loss-making Hungarian SOEs were never allowed to fail during that countrys experiment with market reforms (Kornai, 1979, 1980).
These rms were always rescued, or bailed out, by government
subsidies. Kornai dubbed this phenomenon the SBC effect. The
SBC effect involves the dynamics between a pair of organizations,
the budget-constraint organization (BC-organization) that expects
preferential treatments when in nancial trouble and the supporting organization (S-organization) that comes to its rescue. Most of
the SBC literature focuses on the dynamic relationship between
SOEs in transition economies and their governments.
A government can deploy scal means, credits, or indirect supports to soften an SOEs budget constraint (Kornai et al., 2003). Fiscal means include subsidies and tax concessions granted to certain
rms championed by politicians. State-owned banks under pressure from politicians may offer preferential loans to certain SOEs
to benet the politicians. Some of the oft-used indirect methods
include erecting barriers to entry for foreign competitors and mandating that certain government agencies purchase products from
distressed SOEs.
Since Kornai (1979, 1980), the SBC theory has been formally
modeled and empirically tested by Dewatripont and Maskin
(1995), Schaffer (1998), Berglf and Roland (1998), Lin et al.
(1998), and Frydman et al. (1999), among others. Quoted below
is a paragraph that is highly relevant to our study:
Specically, researchers have asked: Is a state-owned enterprise
more likely to count on a bailout than a private rm? Does a privatized rm have better chances of state rescue than a de novo private rm? Do privatization and bolstering the private sector
reinforce the trend toward hardening the budget constraint? Afrmative answers come from a succession of studies: Giles Alfandari
et al. (1996), EBRD (2000), Anderson et al. (2000), Frydman et al.
(2000), and Schaffer (1998). It is also shown that demonopoliza-
8
Please see Kornai et al. (2003) for a detailed review of the SBC theory and related
empirical evidence.
tion helps harden the budget constraint (Lubomir Lizal et al.,

2001) (Kornai et al., 2003, pp. 1100).
Though Jnos Kornai formulated the SBC theory based on his
observations of the interactions between the Hungarian government and its chronic loss-making SEOs, the theory should also
apply to Chinas privatized former SOEs examined in this study.
In the early days following establishment of Chinas stock
exchanges in the early 1990s, the state chose only the champion
rms from each sector to sell shares to the public. As the stock
market matured over the next two decades, rms of all qualities
were listed and the number of listed rms increased exponentially,
from 14 rms in 1992, to 1086 in 2000, and then to 2494 in 2012.
The state retains substantial ownership in many of these listed
rms. The SBC effect stems from the retained state ownership,
regardless of how well the newly listed company performs after
its IPO. Empirical evidence shows that rm performance is negatively related to state ownership in Chinas SIP rms (Sun and
Tong, 2003; Wei et al., 2005). The SBC phenomenon is not limited
to bailing out loss-making SOEs. Political considerations, such as
obtaining votes or legitimacy, are the oft-cited motives for politicians to help ease a rms credit situation. Politicians are also motivated by paternalism, feeling responsible for an SOEs failure and
taking credit for its success, or by corrupt inuences such as cronyism or bribery (Kornai et al., 2003).
2.2. A snapshot of the Chinese nancial system
The modern Chinese nancial system is dominated by the Big
Four state-owned banks: the Bank of China (BOC), the Construction Bank of China (CBC), the Agricultural Bank of China (ABC),
and the Industrial and Commercial Bank of China (ICBC). Chinas
two stock exchanges, the Shanghai Stock Exchange (SSE) and the
Shenzhen Stock Exchange (SZSE) were established in 1990 and
1991, respectively, and have become another pillar of the nancial
system. Most rms listed on the exchanges are former SOEs that
were restructured or carved out as subsidiaries prior to selling
shares to the public.
Though the Big Four state-owned banks have all recently
become publicly traded companies, they remain rmly under the
states control. Since the establishment of SSE and SZSE, the stock
market has grown exponentially in terms of the number of listed
279

Table 1
The major components of the Chinese nancial markets 20002012.
Year
Listed rms
N
Market cap
(RMB billion)
Corp bonds
(RMB billion)
Bank loans
(RMB billion)
NPL
%
Exchange rate
RMB/US$
Ination (%)
CPI change
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
1086
1154
1223
1285
1373
1378
1434
1550
1635
1718
2063
2342
2494
4809
4352
3833
4246
3706
3243
8940
32,714
12,137
24,394
26,542
21,476
23,036
86
101
133
169
202
402
553
768
1325
2554
3632
4930
7463
9937
11,231
13,129
15,900
17,820
19,469
22,535
26,169
30,339
39,968
47,920
54,795
62,991
22.4
29.8
26
20.4
15.6
8.6
7.1
6.2
2.4
1.6
1.1
1.0
0.9
8.2783
8.2770
8.2770
8.2770
8.2765
8.0702
7.8087
7.3672
6.8346
6.8282
6.6229
6.3009
6.2896
0.35
0.73
-0.77
1.15
3.88
1.82
1.46
4.75
5.86
-0.7
3.31
5.41
2.62
The table presents descriptive statistics of the major components of the Chinese nancial market from 2000 to 2012: the stock market, the bond market, and the banking
sector. Ination is measured as percentage change in Chinas CPI. NPL is non-performing loans to total loans. RMB/US$ exchange rates are the year-end rates from the IMF.
Policy bonds are bonds issued by policy banks owned by the Treasury Department for specic infrastructure projects.
Data sources: Statistical Yearbook of China 20002013 (Statistical Bureau of China); China Financial Stability Report 20072013 (The Peoples Bank of China). Chinas CPI and the
RMB/US$ exchange rates are from IMF International Financial Statistics.
rms and total market capitalization. However, the bond market,

especially the corporate bond market, is severely underdeveloped.9
Table 1 summarizes the growth and relative size of the main components of the Chinese nancial system.
At the end of 2012, the stock market had 2494 listed rms and a
market cap of RMB 23.04 (about US$ 3.66) trillion. The bond market is dominated by treasury bonds and policy bonds (similar to
municipal bonds in the U.S.) and had about RMB 22.55 (US$ 3.58)
trillion bonds outstanding in 2012.10 The corporate bond market
is relatively small compared to the stock market, even though its size
has grown more than ninefold since 2007. Chinas corporate bond
market had RMB 7.46 (US$ 1.19) trillion corporate bonds outstanding
in 2012, about 31% of the size of the stock market.
The most striking fact in Table 1 is that bank loans dominate the
Chinese nancial system. In 2012, there were over RMB 62.99 (US$
10.01) trillion bank loans outstanding, about 8.4 times the size of
the corporate bond market. This suggests that most of the debt
nancing in China comes from bank loans, not from the bond market. This fact is important and highly relevant to our study. If a rm
must go through the scrutiny of the bond market to get credit, it
would have a relatively hard budget constraint, ceteris paribus. If
instead it expects and receives credit from state-owned banks with
the help of politicians, its budget constraint would be relatively
soft. This dynamic has two implications for our study. First, managers in rms with high state ownership do not feel the need to hold
high level of cash because they can always count on easy credit
from state-owned banks in time of distress. In fact, Cull and Xu
(2000) document that state-owned banks in China give preferential treatment to distressed state-owned rms when allocating
credits, while tolerating late or omitted payments on existing
loans. Brandt and Li (2003) also provide direct evidence that private rms in China are required to provide more collateral than
state-owned rms to obtain the same amount of credit. Several
empirical studies also show that bank credits have become the
principal means of softening the budget constraints in many
post-socialist countries (Coricelli and Djankov, 2001; Claessens
and Djankov, 1998; Schaffer, 1998). As an identication strategy,
we triangulate the SBC effect on cash holdings by interacting state
ownership and the amount of bank loans. Because high state ownership rms are more reliant on bank loans, we expect the sensitiv-
9
Ayyagari et al. (2010) and Allen et al. (2011) provide excellent reviews of the
institutional details of the Chinese nancial system.
10
Statistical Yearbook of China, 2013, China State Statistical Bureau (Beijing, China).
ity of cash holdings to bank loans to be high in high state

ownership rms and low at low state ownership rms.11
Second, SBC exacerbates agency problems due to moral hazard.
Managers who operate with a SBC may collude with the controlling
politicians to take on politically expedient projects, as opposed to
NPV maximizing ventures. Table 1 also presents the nonperforming loans (NPL) to total loans ratios for China in 20002012.12
According to the International Monetary Funds (IMF), the Chinese
banking sector has a signicantly higher average NPLs compared
to both the major developed nations and the other large developing
economies.13 Allen et al. (2005) document that a large fraction of
these bad loans resulted from lending decisions based on political
considerations or corrupt inuences, rather than on project merits.
Chinas banking system plays a much bigger role in enterprise
nancing than in countries described in La Porta et al. (1997,
1998) and Levine (2002). Allen et al. (2005) also nd that Chinas
law and institutions investor protection, corporate governance,
accounting standards, and quality of governmentare much less
developed than most of the countries in La Porta et al. (1997,
1998) and Levine (2002). In summary, the Chinese institutional environment is very conducive for the SBC phenomenon.
2.3. China split share structure reform and cash holdings
The Chinese split-share structure reform (the reform, hereafter)
began in 2005 and was largely completed by 2007 (Liao et al.,
2011). The reform allowed non-tradable state shares to be
exchanged for tradable private shareswith a negotiated payment
being made to private shareholders as compensationand thus
allowed the state to sell its heretofore deadweight shareholdings.
As shown in Fig. 1, a marked uptrend in the cash ratio started in
2006. This uptrend may be partially attributed to the reform, since
prior to 2005, state shares and some institutional shares were nontradable; at the conclusion of the reform, all shares became
11
We thank one of the anonymous reviewers for suggesting that we examine the
interaction between bank loans and state ownership as an identication strategy.
12
The last few years have seen dramatic declines in Chinas NPLs. The Wall Street
Journal attributes these declines to the tendency of the countrys banks to routinely
extend or restructure loans to borrowers, or sell them, rather than admit they have
become bad loans or record a loss on the balance sheets. Investors worldwide are very
skeptical about the credit quality trend in China. In fact, the price-to-book values of
Chinas leading banks have been declining, indicating deteriorating credit quality in
China (The Wall Street Journal, December 3, 2013).
13
For example, the average ratio of NPLs to total loans in China over 20002012 is
11.01%, almost twice the level in India (5.66%), the next highest country among major
developing countries. Sources: IMF International Financial Statistics, various issues.
280
tradable, subject to lockups and other restrictions. As rms sell

more previously non-tradable state shares to the public, their cash
holding is likely to increase. In fact, Table 4 (Panel B) shows that
mean cash holdings after the reform is signicantly higher than
before the reform, whereas state ownership is signicantly lower
after the reform. As a robustness check, we perform further analysis of the effect of the reform on cash holdings in Section 4.4.1.
3. Data
equity while the median is 0.05%. The mean change in net external
funds raised (DNFt) is 1.93% of lagged market equity while the
median is zero. The mean change in cash dividends (DDIVt) is close
to zero and the median is zero. The mean market leverage (MLEVt)
is 15.75% and median is 11.33%. The distributional characteristics
of most of these variables are similar to the U.S. based data, as
found in Faulkender and Wang (2006) and others, although the
magnitude is different for some variables. While the U.S. and
Chinese data are not directly comparable, it is helpful to gain a
sense of what the China data look like.
3.1. Full sample statistics

3.2. Subsample statistics14
The required accounting and stock return variables are calculated from nancial statement items and the monthly stock return
les in the China Security Market and Accounting Research
(CSMAR) database, which contains accounting data and stock market data for all rms listed on the Shanghai Stock Exchange (SSE) or
the Shenzhen Stock Exchange (SZSE).
The year 2000 was the rst year that all listed rms in China
were required to adopt a unied set of accounting standards and
principles (Chen et al., 2012). Because most of the variables
employed in this study are calculated from accounting data, we follow Chen et al. (2012) and choose 2000 as the sample starting year
to ensure the consistency of the variables over time. We start with
all rms listed on the two stock exchanges and follow customary
practices to exclude nancial rms, rm years with negative book
equity, rm years with negative net assets (book assets minus cash
and equivalents), rm years with negative dividends, and rm
years that do not have the required stock return. We require a rm
to have a minimum of three consecutive years of data because we
use the average sales growth rate over a three-year period to control for rm growth. Our nal sample is an unbalanced panel data
that consists of 16441 rm-year observations for 2065 unique
rms over the period 20002012.
Table 2 presents variable denitions (Panel A) and summary
statistics (Panel B). All rm level ratios are winsorized at the top
and bottom 1%.
Table 2 (Panel B) shows that an average rm in our sample has a
mean (median) cash holding of approximately 24.3% (15.8%) of
noncash assets, translating into about RMB 1466 million, or US$
233 million at the 2012 exchange rate. Mean and median state
ownership are 21.4% and 5.7%, respectively. The average rm has
total net assets of RMB 6029 million (Real size), approximately
US$ 959 million in 2012 value. To further analyze how cash ratio
is related to leverage, we decompose total liabilities (TL) into Debts
(short-term plus long-term debts) and non-debt liabilities (NDL),
all scaled by net assets. As shown in Panel B, the average rm in
our sample has a total liabilities ratio (TL) of 58.5%, a debt ratio
(Debts) of 26.4%, and a non-debt liabilities ratio (NDL) of 32.1%.
The amount of bank loans a rm receives is central to our main
proposition that state ownership leads to SBC, and a rm with a
SBC holds less cash. SBC is also a main culprit of the inefciency
of state ownership. We obtain the amount of bank loans from
the cash ow statements. As shown Panel B, the average rm has
Bank loans equal of 28.9% of net assets.
Panel B also presents summary statistics for specic variables
for our marginal value of cash analysis. The mean one-year excess
return is 5.05%, while the median one-year excess return is
9.55%. The mean change of cash holdings (DCASHt) is 0.15% of
lagged market value of equity, while the median change is 0.46%.
The mean cash holding at the beginning of the year (CASHt1) is
14.85%, and the median is 9.85%. The mean change in operating
income (DEBITt) is 0.00% of lagged market equity and the median
change is 0.11%. The mean change in net assets (DNAt) is 6.62%
of lagged market equity while the median is 7.58%. The mean
change in interest expenses (DINTt) is 0.13% of lagged market
To better understand the relation between cash holdings and

state ownership, we present in Table 3 additional statistics in
two subsamples, by year (Panel A), by the time periods before, during, and after Chinas split-share reform (Panel B).
Panel A presents the mean and median cash holdings and state
ownership by year for our sample period from 2000 to 2012. As
shown, our sample is an unbalanced panel data. The time trends
of mean cash ratio and mean state ownership are illustrated in
Fig. 1. As shown in Fig. 1, the time trends show that the cash ratio
and state ownership are negatively related in general. As discussed
earlier, the Chinese split-share reform allowed non-tradable state
shares to be exchanged for tradable private shares. The reform
started in 2005 and was largely completed by 2007. As shown in
Panel B, univariate tests indicate that the cash ratio increases signicantly post-reform, whereas state ownership is signicantly
lower post-reform.
4. State ownership and cash holdings
4.1. Methodology the base model
Our main regression model for cash holdings is as follows:
Cashi;t cStatei;t bk X i;t ai kt ei;t
The dependent variable, Cashi,t,, is cash holdings measured as cash

plus cash equivalents, scaled by noncash assets (net assets). Subscripts i and t denote rm i at the end of year t. State ownership
is the focus of our analysis and the main explanatory variable.
SBC theory predicts that state ownership is inherently related to
soft-budget constraints: the higher the state ownership, the softer
the budget constraint, or the less nancially constrained is the rm.
Financially unconstrained rms hold less cash, so we expect a negative relation between cash holdings and state ownership (a negative c).
Xi,t is a k-vector of control variables (k = 1, 2, 3, . . .k). In choosing
the control variables for our multivariate model, we follow Opler
et al. (1999), Almeida et al. (2004), and Kalcheva and Lins (2007).
We control for rm size. Researchers have found that small rms
hold more cash than large rms (Almeida et al. 2004; Bates et al.
2009). As shown in Table 1, bank loans dominate debt nancing
in China. To receive bank loans, rms must use xed assets as collateral or secure third party guarantees (Allen et al., 2005). Because
small rms have less acceptable collaterals than large rms, they
are likely to be more nancially constrained. Therefore, we expect
smaller rms to hold more cash to cope with unforeseen future
liquidity shocks.
14
We also divide the sample rms into ve groups according to which geographical
regions their headquarters are located: Northeast, Coastal, Central, Southwest, and
Northwest. The location dummies are included in our pooled OLS regression to
control for regional disparities in economic development. The location classications
and summary statistics are available in an online appendix accompanying this article.
281

Table 2
Variable denitions and summary statistics.
Variable (symbol)
Denition
Panel A: Variable denitions

Cash
Cash plus marketable securities, scaled by net assets
State
The fraction of shares owned by the state and managed by State Assets Management Authority (SAMA)
Net assets
Total book assets less cash and cash equivalents
Real size
Net assets adjusted using the CPI into 2012 RMB
MVE
Market value of equity, equal year-end number of common shares outstanding times stock price
BM
Book-to-market ratio, total book equity divided by market value of equity
TL
Total liabilities, equal to total book assets minus total book equity, scaled by net assets
NDL
Non-debt liabilities, equal to total liabilities (TL) minus the short-term and long-term debts, scaled by net assets
Debts
The sum of interest-bearing short-term debt and long-term debt, scaled by net assets
Bank loans
Net proceeds from bank borrowing, scaled by net assets. Cash Flow Statement item
NWC
Net working capital, equal current assets less cash and equivalents minus current liabilities, scaled by net assets
Cash ow
Net cash ow from operating activities, a statement of cash ow item, scaled by net assets
CapEx
Capital expenditures, equal net investment in xed assets, a statement of cash ow item, scaled by net assets
Growth
The average sales growth rate over the previous three years period
Firm age
The number of years since a rms IPO, or share-issue privatization (SIP)
Dividend
Equals one if a rm pays cash dividends, and zero otherwise
INST
Institutional ownership, the fraction of shares owned by non-SAMA legal entities, such as mutual funds, insurance companies, or other rms
Foreign
Foreign ownership, the fraction of shares owned by foreign residents including non-Mainland Chinese citizens
Industry sigma
The standard deviation of an industrys cash ow over our sample period
Industries
Chinas 2-digit SIC equivalent B classications dened by China Security Regulatory Commission
Variable
Mean
25th percentile
50th percentile
75th percentile
Stdev
Panel B: Summary statistics

Cash holdings variables
Cash
State
Real size
MVE
BM
TL
NDL
Debts
Bank loans
NWC
Cash ow
CapEx
Growth
Firm age
Dividend dummy
INST
Foreign
Industry sigma
16,441
16,441
16,441
16,441
16,441
16,441
16,436
16,436
15,884
16,441
16,441
16,441
16,441
16,441
16,441
16,441
16,441
16,441
0.2432
0.2139
6029.0
6569.5
0.4216
0.5826
0.3382
0.2433
0.2887
-0.0296
0.0587
0.0736
0.3154
7.7841
0.56
0.1602
0.0184
0.1022
0.0882
0
927.4
1485.7
0.2202
0.4236
0.1986
0.1009
0.1101
-0.1859
0.0032
0.0192
0.0166
4
0
0
0
0.0855
0.1587
0.0569
1742.8
2592.6
0.3641
0.5862
0.2977
0.2357
0.2555
-0.0264
0.0521
0.0521
0.1510
7
1
0.0210
0
0.0967
0.2908
0.4354
3705.3
4988.0
0.5634
0.7346
0.4375
0.3641
0.4207
0.1367
0.1096
0.1052
0.3105
11
1
0.2900
0
0.1184
0.2622
0.2497
41215.3
43132.9
0.2662
0.2250
0.1895
0.1715
0.2257
0.2465
0.1057
0.0720
0.9180
4.7289
0.5
0.2210
0.0755
0.0244
r i;t RBi;t
16,444
0.0505
0.2790
0.0955
0.0984
0.5707
STATE
DCASHt
CASHt1
DEBITt
DNAt
DINTt
DDIVt
DNFt
MLEVt
16,444
16,444
16,444
16,444
16,444
16,444
16,444
16,321
16,439
0.2140
0.0015
0.1485
0.0000
0.0662
0.0013
0.0007
0.0193
0.1575
0
0.0436
0.0484
0.0196
0.1597
0.0024
0.0016
0
0.0377
0.0569
0.0046
0.0985
0.0011
0.0758
0.0005
0
0
0.1133
0.4354
0.0556
0.1855
0.0211
0.3178
0.0049
0.0044
0.0034
0.2411
0.2497
0.1522
0.1609
0.0571
0.6258
0.0129
0.0157
0.0584
0.1485
Value of cash variables
r i;t RBi;t is excess return, where r i;t is rm is monthly-compounded annual stock return in year t (scal year-end) and RBi;t is stock is benchmark portfolio return at year t. All
variables except excess return and MLEV are deated by lagged market value of equity, MVEt1. DXt = Xt Xt1. CASH is cash plus cash equivalents. EBIT is operating income
before interest and taxes. NA is book assets less cash and cash equivalents. INT is interest expenses. DIV is cash common dividends. NF is net external funds raised, equal to
the sum of net proceeds from equity and debt issuance. MLEV is market leverage, dened as short-term debts plus long-term debts, scaled by market value of equity.
Subscript (t-1) means the beginning of scal year t.
We also control for rm age, rm growth, industry cash ow

volatility, capital expenditures, debt, net working capital, dividends, and a rms geographic location. We control for rm age,
dened as the number of years since IPO. Bates et al. (2009) document that IPO rms hold more cash than non-IPO rms in the United States, so we conjecture that the more recently a rm has its
IPO the more cash it holds, all else equal. Firms with more growth
opportunities are expected to hold more cash because cautious
managers are aware of the costs associated with underinvestment
in positive NPV projects if cash shortfalls occur. Firms that operate
in an industry with more volatile cash ows are expected to hold

more cash to hedge against unforeseeable cash shortfalls. Firms
expecting high capital spending in the coming year are expected
to hold more cash in the current year to avoid the costs associated
with being unable to make scheduled capital investments. Debt
and working capital can serve as cash substitutes. Therefore, debt
and working capital are expected to be negatively related to cash
holdings.
The prediction of the effect of dividends on cash holdings is less
clear. On the one hand, dividend-paying rms can always cut or
282
Table 3
Cash holdings and state ownership subsamples statistics.
Year
Cash holdings
Panel A: Cash holdings and state ownership by year

2000
830
2001
944
2002
1007
2003
1056
2004
1096
2005
1162
2006
1162
2007
1209
2008
1303
2009
1364
2010
1458
2011
1785
2012
2065
Before the reform (20002004)
N
(1)
Mean
(2)
Median
State ownership
Mean
Median
Mean
Median
0.187
0.228
0.212
0.202
0.192
0.189
0.184
0.201
0.207
0.259
0.288
0.336
0.328
0.128
0.162
0.154
0.147
0.135
0.134
0.131
0.139
0.147
0.181
0.187
0.198
0.199
0.347
0.356
0.356
0.357
0.348
0.333
0.283
0.247
0.215
0.120
0.087
0.057
0.043
0.384
0.394
0.397
0.396
0.385
0.360
0.293
0.250
0.186
0.000
0.000
0.000
0.000
During the reform (20052007)

N
(3)
Mean
Panel B: Cash holdings and state ownership before, during and after the split-share reform
Cash
5673
0.195
0.139
3533
0.191
State
5673
0.352
0.389
3533
0.287
(4)
Median
0.135
0.298
After the reform (20082012)
Difference
(5)
Mean
(6)
Median
(5)(1)
Mean
7975
7975
0.291
0.095
0.184
0
0.095
0.256
, , indicate signicant at the 1%, 5%, and 10% levels, respectively.

This table presents mean and median of state ownership and cash holdings for two subsamples. Panel A presents cash holdings and state ownership by year from 2000 to
2012. Panel B presents cash holdings and state ownership for rm-years observations in three different time periods: before the split-share reform (20002004), during the
reform (20052007), and after the completion of the reform (20082012). Cash holdings (Cash) is cash ratio, dened as cash and cash equivalents divided by net assets. Net
assets is total book assets minus cash and cash equivalents. State ownership (State) is the fraction of shares owned by the state and managed by State Assets Management
Authority (SAMA).
eliminate dividends to meet cash shortfalls. If this is the case, dividend-paying rms are expected to hold less cash than non-paying
rms. On the other hand, rms rarely cut dividends, much less
eliminate them, unless they are in deep nancial distress. Dividend-paying rms may hold more cash in anticipation of the dividends to be paid in the coming period.
Lastly, we include institutional and foreign ownership as control variables. Shleifer and Vishny (1986) argue that institutional
shareholders help mitigate free rider problems and reduce managerial opportunism by forcing managers to disgorge excess cash.
Institutional shareholders also act to promote their own interest,
which can differ from that of other shareholders (Shleifer and
Vishny, 1997). Empirically, Harford et al. (2008) nd no signicant
relation between cash holdings and institutional ownership after
controlling for lagged cash holdings. In the case of China, many
of the institutional owners are owned or controlled by various levels of government, and they also have a prot maximizing motive
(Wei et al., 2005). These two characteristics point to a negative
relation between institutional ownership and cash holdings. Several studies have found that foreign ownership is positively related
to cash holdings. DeFond et al. (2011) examine a multi-country
sample of rms and nd a positive relation between institutional
foreign ownership and the level of corporate cash holdings. Luo
and Hachiya (2005) study cash holdings in Japanese rms and nd
that foreign ownership is positively related to cash holdings.
Dahlquist and Robertsson (2001) study foreign ownership and rm
characteristics in Swedish rms and nd that foreign shareholders
prefer rms with large cash positions on their balance sheets.
These researchers argue that a high cash ratio indicates a good
liquidity position, a good level of protability, and low information
asymmetry, all preferred by foreign investors. Therefore, we expect
a positive relation between cash holdings and foreign ownership in
our analysis.
There are two methods commonly used to estimate similar
models in the corporate nance literature. One is the pooled ordinary least squares (Pooled OLS) regression controlling for industry
and year effects, and the other is the panel regression controlling
for rm xed effects (Panel FE). Though we also present the Pooled
OLS results, we base our inferences on the Panel FE results. Our
main regression model (1) includes rm xed effects, ai, which
help eliminate time-invariant omitted variable bias, and year xed
effects, kt, which help control for economy-wide yearly uctuations. The reported t-statistics are based on robust standard errors
adjusted for potential heteroscedasticity.
4.2. Empirical results
The empirical results are presented in Table 4. Column (1) presents the Pooled OLS regression results, while columns (2)(4)
present the Panel FE regression results using different leverage
measures. Columns (1) and (2) employ short-term debts plus
long-term debts scaled by net assets (Debts) as leverage measure,
while columns (3) and (4) use total liabilities scaled by net assets
(TL) and no-debt liabilities scaled by net assets (NDL) as leverage
measures, respectively. We observe several consistent ndings in
Table 4. The main explanatory variable, state ownership, State,
has a negative and highly signicant coefcient in all of the four
models, consistent with our hypothesis that rms with high state
ownership hold less cash. State has a coefcient of 0.119 in column (1) and 0.092 in column (2). These results suggest that, for
the typical rm in our sample with an average real net assets of
RMB 6026 million (Table 3, Panel B), a 10 percentage-point
decrease in state ownership leads to about RMB 71.7 million (or
US$ 11.5 million) increase in cash holdings in the Pooled OLS
model in column (1) and RMB 55.5 million (or US$ 8.7 million) in
the Panel FE model in column (2).15
The results further show that smaller rms and younger rms
hold more cash. Debts and net working capital are signicantly
15
For example, for a 10 percentage-point decrease in state ownership, the change in
cash holdings is (Pooled OLS): (0.119) (0.10) = 0.0119, or 1.19% of real assets, all
other variables are evaluated at means. The average rm in our sample has real assets
of RMB 6029 million. This translates into 0.0119 6029 = RMB 71.7 million increase in
cash holdings, or about US$ 11.5 million in 2012 exchange rate.
283

Table 4
The determinants of cash holdings: Pooled OLS and Panel xed effect (FE) regression results.
State
Log (real size)
Log (rm age)
Pooled OLS
Panel FE
(1)
(2)
(3)
(4)
0.1196
(9.67)
0.0449
(11.82)
0.0752
(16.17)
0.0918
(7.00)
0.0371
(5.93)
0.0468
(8.30)
0.0953
(7.42)
0.0825
(11.99)
0.0372
(6.61)
0.3588
(14.90)
0.0810
(6.33)
0.0579
(9.18)
0.0500
(8.93)
0.2049
(9.39)
0.2887
(11.44)
TL
Debts
NDL
CapEx
Dividend
Cash ow
NWC
Growth
INST
Foreign
Industry sigma
Constant
Location dummies
Industry dummies
Year dummies
Firm xed effects
Obs.
R2 overall
0.1124
(2.77)
0.0595
(10.99)
0.5907
(16.66)
0.0862
(4.19)
0.0068
(2.31)
0.1228
(8.09)
0.1260
(2.53)
1.0149
(9.13)
1.2565
(14.32)
Yes
Yes
Yes
No
16,436
0.335
0.1279
(3.94)
0.0305
(7.61)
0.2885
(11.24)
0.2366
(10.74)
0.0088
(3.07)
0.0936
(6.27)
0.1441
(2.50)
0.7865
(8.82)
1.0859
(8.33)
No
No
Yes
Yes
16,436
0.286
0.1957
(5.98)
0.0392
(9.75)
0.3785
(15.51)
0.0253
(1.21)
0.0071
(2.40)
0.1101
(7.51)
0.1700
(3.27)
0.7916
(9.00)
1.7615
(12.65)
No
No
Yes
Yes
16,441
0.208
0.3338
(13.53)
0.1823
(5.64)
0.0348
(8.82)
0.2926
(11.77)
0.0905
(4.92)
0.0063
(2.21)
0.0933
(6.37)
0.1563
(3.00)
0.7124
(8.30)
1.3693
(10.45)
No
No
Yes
Yes
16,436
0.288
The dependent variable is cash holdings (Cash) measured as cash plus cash equivalents over net assets. Net assets is total books assets minus Cash. State is state ownership.
Real size is net assets adjusted using Chinese CPI into 2012 RMB. Firm age is the number of years since its IPO. Debts is the sum of short-term debt and long-term debt scaled by
net assets. CapEx is Capital expenditures scaled by net assets. Dividend is a dummy equal to one if a rm pays cash dividends and zero otherwise. Cash ow is net cash ow
from operating activities scaled by net assets. NWC is current assets less cash and equivalents minus current liabilities, scaled by net assets. Growth is the average sales growth
rate over the previous three-year period. Sigma is the standard deviation of an industrys cash ow over the sample period. INST is the fraction of shares owned by non-SAMA
legal entities. Foreign is foreign ownership. Geo location dummies are indicator variables correspond to ve geographic locations: Northeast, Coastal, Central, Southwest, and
Northwest. t-Statistics (in the parentheses) are based on robust standard errors. *** Signicant at the 1% level. ** Signicant at the 5% level. * Signicant at the 10% level.
negatively related to cash holdings, indicating that they may

behave like cash substitutes. Table 4 also shows that cash ratio is
signicantly positively related to rm protability, rm growth,
and industry cash ow volatility (Industry sigma). These ndings
are consistent with our predictions and with empirical evidence
for U.S. rms (Opler et al., 1999 and Harford, 1999), and other
international studies (Dittmar et al., 2003; Ozkan and Ozkan,
2004; Kalcheva and Lins, 2007). We further observe that dividend-paying rms hold a higher level of cash, contrary to ndings
in the studies cited above, perhaps suggesting that dividend-paying rms seldom cut dividends even during stressful periods. As
discussed in Section 2, it is very difcult to raise funds from the
severely underdeveloped corporate bond market and the seasoned
equity market in China.16 Dividend-paying rms in China hold more
cash to avoid a situation in which they have to raise outside funds to
support their dividend policies.
Table 4 shows institutional ownership (INST) is signicantly negatively related to cash holdings across all specications. There are
16
The Chinese Security Regulatory Commission (CSRC) uses return of equity (ROE)
as a criterion for rights offerings and seasoned new issues. This criterion has changed
over time. The latest requirement is that a rm must have a three-year average ROE
greater than 6% to be eligible for rights offerings and seasoned new issues (Liu and Lu,
2007).
two plausible explanations for this. First, institutional investors such

as mutual funds and pension funds may have the power to force
rms to disgorge excess cash holdings and, second, many institutional shares are controlled or owned by different levels of governments, and therefore have easy access to credit in state-owned
banks. The latter seems more plausible given that rms operate in
a credit environment conducive to the SBC effect. Finally, the results
show that cash holdings and foreign ownership are positively
related, consistent with the existing empirical evidence.
Most studies in the existing cash holdings literature use shortterm debts plus long-term debts, scaled by either net assets or total
book assets, to control for leverage (Kalcheva and Lins, 2007; Opler
et al., 1999; Bates et al., 2009, among others). These studies nd
cash holdings to be highly negatively related to leverage. Chen
et al. (2012) use total liabilities over net assets (TL) as their control
for leverage in their study on cash holdings and corporate governance in Chinas listed rms. They nd cash holdings to be significantly positively related to TL. As shown in columns (1) and (2),
we use short-term debts plus long-term debts over net assets as
our leverage measure (Debts), and nd cash holdings to be highly
negatively related to leverage. To reconcile these seemingly
inconsistent ndings, we decompose total liabilities (TL) into two
components, short-term debts plus long-term debts (Debts), and
284
Table 5
State ownership, bank loans, and cash holdings Panel FE regression results.
Panel A: Regression results

State
Bank loans
State Bank loans
(1)
(2)
0.1063
(7.31)
0.1000
(7.81)
0.1645
(4.68)
0.0488
(6.62)
0.1207
(8.15)
0.1065
(5.63)
0.0500
(23.54)
0.0812
(24.85)
0.0946
(2.98)
0.0595
(15.94)
0.6131
(24.11)
0.0431
(3.81)
0.0066
(3.06)
0.0410
(4.16)
0.0981
(3.34)
0.7983
(8.61)
1.3852
(28.23)
15,884
0.334
State_dummy Bank loans

0.0493
(23.28)
0.0834
(25.19)
0.0896
(2.81)
0.0596
(15.97)
0.6188
(24.26)
0.0423
(3.73)
0.0073
(3.34)
0.0614
(5.39)
0.1028
(3.49)
0.7927
(8.58)
1.3738
(28.03)
15,884
0.334
Log(real size)
Log(rm age)
CapEx
Dividend
Cash ow
NWC
Growth
INST
Foreign
Industry sigma
Constant
Obs.
R2 overall
State
(%)
Change
in bank
loans (%)
Effect
on cash
ratio
(%)
Mean net
assets
(RMB
million)
Change
in cash
(RMB
million)
Change
in cash
(US$
million)
Panel B: The marginal effects continuous state ownership

75
+10
7.7
6094.7
471.6
50
+10
5.5
6094.7
334.7
25
+10
3.2
6094.7
197.8
0
+10
1.0
4611.1
46.1
75.0
53.2
31.4
7.3
Panel C: The marginal effects

State-dummy
Change
in bank
loans
state ownership as a dummy

Change in
Mean net
Effect
on cash assets (RMB cash (RMB
million)
million)
ratio
Change in
cash (US$
million)
1
0
5.0
1.2
+10
+10
6094.7
4611.1
305.9
55.7
48.6
8.8
The dependent variable is cash holdings (Cash) measured as cash plus cash equivalents over net assets. Net assets is total books assets minus Cash. State is state
ownership. Real size is net assets adjusted using Chinese CPI into 2012 RMB. Firm age
is the number of years since its IPO. Bank loans is net proceeds from bank borrowings (Cash Flow Statement item), scaled by net assets. CapEx is Capital
expenditures scaled by net assets. Dividend is a dummy equal to one if a rm pays
cash dividends and zero otherwise. Cash ow is net cash ow from operating
activities scaled by net assets. NWC is current assets less cash and equivalents
minus current liabilities, scaled by net assets. Growth is the average sales growth
rate over the previous three-year period. Sigma is the standard deviation of an
industrys cash ow over the sample period. INST is the fraction of shares owned by
non-SAMA legal entities. Foreign is foreign ownership. Year effects and rm xed
effects are controlled for in both models. t-Statistics (in the parentheses) are based
on robust standard errors. *** Signicant at the 1% level. ** Signicant at the 5%
level. * Signicant at the 10% level.
The average net assets in rms with and without state ownership are RMB 6094.7
million and RMB 4611.1 million, respectively. Take Panel B, rst row (at 75% state
ownership), as an example of the calculations of the marginal effect of the interaction of bank loans and state ownership. In a rm with 75% state ownership (high),
a 10 percentage-point increase in bank loans results in (see Panel A, column (1) for
the coefcients): 0.1063 (0.75) 0.1000 (+0.10) + 0.1645 (0.75) (+0.10) =
0.077, or 7.7% of net assets, or 0.077 6094.7 = RMB-471.6 million. All other
independent variables are evaluated at their means.
non-debt liabilities (NDL), all scaled by net assets. We perform separate panel FE regressions using TL and NDL as alternative measures of leverage, as shown in columns (3) and (4).
We observe that the coefcient of total liabilities (TL) in column (3) is positive and signicant, consistent with Chen et al.
(2012). Interestingly, column (4) shows that cash holdings is also
signicantly positively related to non-debt liabilities (NDL). One
possible explanation is that rms with high level of non-debt liabilities (NDL) need to hold high level of cash to meet their precommitted obligations. Though the relation between cash holdings and leverage is not a main focus of the paper, these ndings
are interesting and are new contributions to the cash holdings
literature.
4.3. State ownership, bank loans, and cash holdings
The main proposition in our cash holdings analysis is that state
ownership leads to soft-budget constraint (SBC), and rms with
SBC hold less cash. As discussed earlier, Chinese nancial system,
dominated by state-owned banks, is fertile ground for SBC syndromes. The interaction between state ownership and bank loans
provides cross-section identication for our hypothesis. At high
state ownership, rms have relatively softer budget constraints,
and hence rely more heavily on loans from state-owned banks
for liquidity needs. Conversely, at low state ownership, rms have
relatively harder budget constraints, and hence could not rely on
bank loans for liquidity needs. In sum, a rms cash holdings
should be more sensitive to change in bank loans at high state
ownership and less sensitive at low state ownership. To test this
proposition, we add the interaction term between state ownership
and bank loans, Statei,t Bankloansi,t, to Eq. (1):
Cashi;t cStatei;t Bankloansi;t Statei;t Bankloansi;t

bk X i;t ai kt ei;t
where Bankloansi,t is rm is net proceeds from bank borrowings at

year t, scaled by net assets. The regression results are presented in
Table 5. State ownership, State, in model (1) is a continuous variable, while state ownership in model (2) is a dummy variable
(State-dummy) that equals one if a rm has state ownership and
zero otherwise. The coefcients of the interaction terms in both columns are positive and highly signicant. This suggests that the
interaction between state ownership and bank loans has a statistically signicant and positive effect on a rms cash holdings. To
interpret the marginal effects on cash holdings, we must evaluate
state ownership, bank loans, and their interaction term simultaneously, while the other variables are evaluated at their means.
Panels B and C of Table 5 provide the interpretations of the marginal
effects of state ownership, bank loans, and their interactions on cash
holdings.
As shown in Panel B, at 75% state ownership, a 10 percentagepoint increase in bank loans leads to a 7.7 percentage-point
decline in cash, or about RMB 472 (US$75) million. At 25% state
ownership, a 10 percentage-point increase in bank loans leads
about RMB 198 (US$ 31) million reduction in cash. At zero state
ownership, a 10 percentage-point increase in bank loans leads
to about RMB 46 (US$ 7) million reduction in cash. As shown in
Panel C, in rms with state ownership, a 10 percentage-point
increase in bank loans leads to about 5 percentage-point reduction in cash holdings, corresponding to about RMB 306 (US$ 49)
million reduction in cash holdings. In rms with no state ownership, a 10 percentage-point increase in bank loans leads to only
about RMB 56 (US$ 9) million reduction in corporate cash
285

Table 6
Robustness checks - Panel FE regression results.
Effects of the reform
State
Firm age
Debts/net assets
Capital expenditures/net assets
Dividend dummy
Cash ow/net assets
Net working capital/net assets
Growth
Institutional ownership
Foreign ownership
Industry sigma
Constant
Obs
R2 overall
AR(1) test (p-value)
AR(2) test (p-value)
Hansen test of overidentication (p-value)
diff-GMM
(1)
(2)
(3)
(4)
0.0924***
(6.37)
0.0323**
(2.16)
0.0872***
(10.07)
0.0408***
(6.44)
0.0783***
(11.7)
0.2538***
(8.98)
0.0948***
(2.56)
0.0310***
(6.90)
0.2976***
(10.61)
0.2439***
(10.14)
0.0062**
(2.15)
0.0175
(0.98)
0.0973
(1.44)
0.6197***
(6.12)
1.1676***
(8.84)
12,904
0.3127
0.0561***
(4.08)
0.1104***
(2.88)
0.0533***
(8.51)
0.0532***
(9.63)
0.0841***
(2.94)
0.0409*
(1.74)
0.0604
(0.78)
0.1405***
(2.91)
0.0557
(1.54)
0.1099
(0.49)
0.1433**
(2.09)
0.0089**
(1.95)
0.1361*
(1.88)
1.3714*
(1.87)
1.4194***
(4.91)
Reform
Log (real size)
Reduced form
0.0331***
(5.21)
0.0476***
(7.69)
0.3017***
(10.48)
0.1095***
(2.90)
0.0286***
(6.35)
0.2862***
(10.03)
0.2547***
(10.39)
0.0075***
(2.50)
0.0774***
(4.38)
0.1524**
(2.13)
0.7830***
(7.57)
1.0164***
(7.64)
12,904
0.2854
0.3849***
(15.36)
0.1729***
(8.74)
0.0094***
(3.18)
0.062***
(4.07)
0.1411***
(2.54)
0.6268***
(6.53)
1.3855***
(10.56)
16,441
0.2132
14,883
0.000
0.322
0.503
The dependent variable is Cash measured as cash plus cash equivalents over net assets. Net assets is books assets minus Cash. State is state ownership. Reform is an indicator
variable equal to one if rm-years are from 2000 to 2004, and zero if rm-years are from 2008 to 2012. Real size is net assets adjusted using Chinese CPI into 2012 RMB. Firm
age is the number of years since its IPO. Debts is the sum of short-term debt and long-term debt scaled by net assets. CapEx is capital expenditures scaled by net assets.
Dividend is a dummy equal to one if a rm pays cash dividends and zero otherwise. Cash ow is net cash ow from operating activities scaled by net assets. NWC is current
assets less cash and equivalents minus current liabilities, scaled by net assets. Growth is the average sales growth rate over the previous three years period. Industry sigma is
the standard deviation of an industrys Cash ow over our sample period. INST is institutional ownership. Foreign is foreign ownership. Year effects and rm xed effects are
controlled for in all models. t-Statistics (in the parentheses) are based on robust standard errors.
*
Signicant at the 10% level.
**
***
holdings. These results suggest that the marginal effect of the

interaction between state ownership and bank loans is not only
statistically but economically signicant. These results further
show that the sensitivity of cash holdings to bank loans is high
when state ownership is high and low when state ownership is
low. The results in Table 5 provide strong evidence that state
ownership is linked to soft-budget constraints, and therefore,
rms with high state ownership hold less cash.
4.4. Robustness checks
4.4.1. The effect of the split-share structure reform on cash holdings
The Chinese Security Regulatory Commission (CSRC) carried out
the so-called Split Share Structure Reform in 20052007. Prior to
2005, China had a dual-share system within which there were two
types of shares, tradable and non-tradable. State shares and some
institutional shares were non-tradable shares, and the purpose of
the reform was to convert non-tradable shares into tradable
shares. The reform started in 2005 and by the end of 2007, 97%
the A-share listed rms had completed the reform (Li et al.,
2011). At the conclusion of the reform, all shares become tradable,
regardless of ownership.17 As shown in Fig. 1, cash holdings exhibits
a signicant uptrend starting in 2006. Table 4 (Panel C) also shows
17
See Liao et al. (2011) for detailed descriptions of the split-share reform process.
that the post-reform cash ratio is higher than that pre-reform, suggesting this uptrend may be partially due to the reform. As rms sell
more previously non-tradable shares to the public, their cash holdings is likely to increase. To account for the potential effect of the
reform on cash holdings, we exclude the rm-years observations
in 2005, 2006, and 2007, and re-estimate our main model (1) with
panel FE regression. The results from the truncated sample, as shown
in column (1) of Table 6, are similar and consistent with those in
Table 4. In particular, the coefcient of State (0.0924) is almost
identical to the coefcient of State in Table 4 (column (2)) (0.0918).
Chen et al. (2012) study cash holdings surrounding the split share
reform in Chinas listed rms from 2000 to 2008. They document a
signicant decrease in cash holdings following the split share reform.
Their ndings seem to contradict the time series pattern in Fig. 1 of
this study, which shows a dramatic uptrend in cash holdings postreform. Though the main focus of our paper is the relation between
state ownership and cash holdings, the effect of the reform on cash
holdings deserves further examination. As shown in Table 3 (Panel
B), a univariate test nds that mean cash holding post-2007 is significantly higher than the pre-2005 mean. To investigate the effect of
the reform on cash holdings in a multivariate setting, we construct
a dummy variable, Reform, that equals one if an observation falls in
the post-reform years, 20082012, and zero if an observation falls
in the pre-reform years, 20002004. Firm-year observations in
286
20052007 are omitted to provide a cleaner comparison of cash

holdings before and after the reform. We add Reform to our main
regression model (1) and re-estimate with panel FE regression.
The results are presented in Table 6 (column (2)). Our main coefcients of interest are those of Reform and State. Reform has a coefcient of 0.087, positive and highly signicant (with a robust
t-statistics of 10.07), indicating a signicant increase in cash holdings
post-reform. An average rm in our sample holds about RMB 526
million (or US$ 83 million in 2012 value) more in liquid assets in
the post-reform years than in the pre-reform years. The coefcient
of State is -0.0323, signicant at the 5% level. As shown in Table 3
(Panel B), the average rm in our sample experiences a decrease of
25.6 percentage-points (0.256) in state ownership from pre- to
post-reform. This translates into an increase of about RMB 50 million
(or US$ 7.9 million) in cash holdings post-reform for the average rm.
This suggests that after controlling for the reform, the relation
between cash holdings and state ownership remains signicantly
negative. We further observe that the coefcient of State in column
(2) is signicantly smaller in magnitude than that in column (1), suggesting that the reform can explain a signicant portion of the
increase in cash holdings from 2008 to 2012.
Our nding of a dramatic increase in cash holdings in the postreform years seems contradictory to Chen et al. (2012) who nd a
decrease in cash holdings post-reform. One possible explanation is
that the sample in Chen et al. (2012) ends at 2008. In their sample
of 1293 unique rms, 213 completed the reform in 2005, 721 in
2006, 64 in 2007, and 18 in 2008. Chen et al. (2012) construct
rm-specic time dummies After0, After1, and After2, to indicate the
year of the reform, 1 year after the reform, and 2 years after the
reform, respectively. Their results show signicant and negative
coefcients for After0 and After1, but insignicant coefcient for
After2 (pp. 3623, column (3)). The reform is considered complete
when the reform proposal is approved by a super-majority of tradable shareholders and all shareholders. However, each reform plan
must contain a compulsory 12-month lockup to restrict non-tradable shareholders from selling their shares immediately after the
reform plan becomes effective. In addition, non-tradable shareholders are only allowed to sell a maximum of 5% of the total shares outstanding within a 12-month period and 10% over a 24-month period
(Liao et al., 2011). In other words, it takes time for the reform to
have an effect on cash holdings. Therefore, we argue that dummies
After0, After1, and Aftter2 in Chen et al. (2012) may not fully capture
the effect of the reform on cash holdings.
4.4.2. Potential simultaneity among leverage, cash holdings, and
capital expenditures
The static tradeoff theory of cash holdings suggests that rms
choose leverage, cash holdings, and investment level simultaneously (Opler et al., 1999). As a robustness check, we follow
Opler et al. (1999) and omit capital expenditures, leverage, and
dividend variables from the main regression model. We then reestimate the reduced form model with panel FE regression. The
results, presented in column (3) of Table 6, largely support the
same conclusions as those in Table 4 for the non-omitted explanatory variables. In particular, our main conclusion holds in that cash
holdings and state ownership are negatively related.
4.4.3. Endogeneity
When carrying out Chinas share-issue-privatization program,
the government chooses which sectors and which specic rms
to retain and even strengthen control, while relinquishing control
and letting market forces work in certain sectors and rms. In
other words, the governments choices of which rms to privatize
and how much ownership to retain are non-random. Reverse causality between state ownership and corporate cash holdings is
unlikely to be an issue in this study, since it is highly unlikely that
the government changes its ownership stake in a rm based on the

rms level of cash holdings. However, other sources of endogeneity remain, such as unobserved rm heterogeneity. In addition,
other rm characteristics, such as rm growth, leverage, dividend
policy, capital expenditure, institutional ownership, and foreign
ownership, may be potentially endogenous to rm cash holdings.
To control for the aforementioned sources of potential endogeneity, we employ the ArellanoBond rst-difference Generalized
Method of Moment (diff-GMM, hereafter) (Arellano and Bond,
1991) estimation method. Our panel dataset has a relatively short
time dimension and a large unique-rm dimension. The diff-GMM
estimator is suitable for such a panel. More importantly, the diffGMM estimator is an effective method to control for the unobserved
rm heterogeneity and the potential endogeneity of other regressors.
Specically, we estimate a static regression model (1) via the ArellanoBond two-step method.18 We assume two strictly exogenous variables: rm age and year dummies. All other independent variables
are assumed to be endogenous and lagged twice. The lags of the endogenous variables are employed as instruments (IVs). Heteroskedasticity
is controlled for by using robust standard errors. The results from the
diff-GMM method are presented in Table 6 (column (4)).
In column (4), we also report the results of the model specication tests. AR(1) and AR(2) are tests for rst-order and second-order
serial correlation in the rst-differenced residuals, under the null of
no serial correlation. The AR(2) test yields a p-value of 0.322, indicating the null of no second-order serial correlation cannot be rejected.
The Hansen test of over-identication is used to examine the validness of the instruments (IVs) in the diff-GMM method, under the null
that all IVs are valid. The Hansen test yields a p-value of 0.503, which
means we cannot reject the null that all IVs are valid. As shown in
column (4), the diff-GMM method yields a coefcient of -0.1104
for state ownership (State), signicant at the 1% level. This suggests
that after controlling for potential endogeneity of state ownership,
unobserved rm heterogeneity, and potential endogeneity of other
regressors, our overall result is robust in that cash holdings is significantly and negatively related to state ownership.19
5. State Ownership and the Value of Cash
5.1. Methodology
To estimate the marginal value of cash, we employ the
Faulkender and Wang (2006) model with modications to test
our hypothesis: we add state ownership and the interaction
between state ownership and change in cash to their original specications. 20 Our model is as follows:
DCASHi;t
DEBITi;t
DNAi;t
DINTi;t
b2
b3
b4
MVEi;t1
MVEi;t1
MVEi;t1
MVEi;t1
DNFi;t
DDIVi;t
CASHi;t1
b5
b6
b7
b8 MLEVi;t
MVEi;t1
MVEi;t1
MVEi;t1
CASHi;t1 DCASHi;t
DCASHi;t
b9

b10 MLEVi;t
MVEi;t1
MVEi;t1
MVEi;t1
DCASHi;t
b11 STATEi;t b12 STATEi;t
ei;t
3
MVEi;t1
ri;t RBi;t b0 b1
18
We thank one of the anonymous reviewers for suggesting that we estimate a
static model that does not include the lagged dependent variable as independent
variable. We employ the xtabond2 procedure in STATA as detailed in Roodman
(2009).
19
We also estimate equation (1) using the system GMM estimator (Blundell and
Bonds, 1998), and obtain a negative and signicant coefcient for state ownership.
The results are available in the online appendix accompanying this article.
20
Dittmar and Mahrt-Smith (2007) also employ a modied version of the
Faulkender and Wang (2006) model in their examination of governance and value
of cash.
The dependent variable is excess annual stock return dened as

r i;t RBi;t , where r i;t is rm is monthly-compounded annual stock
return in year t (scal year-end) and RBi;t is stock is benchmark
portfolio return in year t. Faulkender and Wang (2006) use the
25 Fama and French (1993) portfolios formed on size and bookto-market ratio as their benchmark portfolios. Since there are
no such portfolios readily available for Chinas stock market,
we follow Fama and French (1993) and construct our own
benchmark portfolios on size and book-to-market ratios.21 Wang
and Xu (2004) employ the FamaFrench three-factor model to study
the Chinese stock market and nd the explanatory power of threefactor model ranges from 81% to 90% of stock returns in the cross
section.
The independent variables in Eq. (3) are rm specic factors
similar to those in Faulkender and Wang (2006). They are dened
as follows. CASHi,t is cash holdings for rm i at time t. INTi,t is interest expense. NFi,t is net external funds raised for rm i in year t,
dened as net proceeds from bond issuance and seasoned equity
offerings (cash ow statements items). MLEVi,t is market value
leverage and is calculated as short-term debt plus long-term debt
divided by the sum of short-term debt, long-term debt and market
value of equity. NAi,t is net assets. EBITi,t is operating earnings
before interest and taxes. STATEi,t is state ownership. DXi,t indicates
the unexpected change in variable X for rm i from time t-1 to time
t, DXi,t = Xi,t Xi,t1. We initially use the realized change, assuming
the expected change is zero, and then conduct various robustness
tests using alternative estimates of expected change in cash to calculate the unexpected change in cash holdings.
Since annual stock return is (MVEi,t MVEi,t1) divided by
MVEi,t1, and all the explanatory variables except market leverage
are scaled by lagged market value of equity, MVEi,t1, this standardization allows interpretation of the estimated coefcients as
the dollar change in value for a one-dollar change in the corresponding explanatory variable. Following Faulkender and Wang
(2006), we include two interaction terms,
MLEVi;t
DCASHi;t
.
MVEi;t1
CASHi;t1
MVEi;t1
DCASHi;t
MVE
i;t1
and
We want to test what effects cash levels and debt
levels have on the marginal value of cash in Chinas privatized

rms. For U.S. based rms, the coefcients of these two interaction
terms are signicantly negative, indicating the marginal value of
cash declines with larger cash holdings and higher leverage.
We add a third interaction term to the model, the interaction
between state ownership and change in cash holdings,
DCASH
STATEi;t MVEi;t1i;t . This interaction term captures the relationship
between state ownership and change in cash holding and is one
of the main contributions of the paper. State ownership has been
linked to agency problems due to ineffective monitoring and poor
incentives (Shleifer and Vishny, 1994; Boycko et al., 1996). The SBC
effect inherent in state ownership exacerbates these agency problems. Recent studies show that the marginal value of cash declines
with higher agency costs and poor corporate governance (Dittmar
et al., 2003; Pinkowitz et al., 2006; Kalcheva and Lins, 2007;
Dittmar and Mahrt-Smith, 2007; Harford et al., 2008; Liu and
Mauer, 2011). In addition, managers in rms with SBC may collude
with politicians to undertake politically expedient projects, as
opposed to NPV maximizing projects, leading to lower return on capital. Therefore, we expect a negative coefcient for the interaction
DCASH
term, STATEi;t MVEi;t1i;t .
21
We choose to construct 16 benchmark portfolios for the Chinese market instead
of the 25 benchmark portfolios in Fama and French (1993). This is because in the
Chinese stock market, the number of listed rms is much smaller than that in the U.S.
stock market. The steps of constructing our benchmark portfolios are detailed in the
online appendix accompanying this article.
287
5.2. Empirical results

Our main objective in this section is to quantify the effect of
state ownership on the value of the next RMB of cash raised or
retained by the rm. We also wish to measure the marginal value
of cash for the average rm in our sample. The third objective is to
test whether or not the marginal value of cash declines with higher
levels of cash and with higher levels of debt, as is the case in U.S.
studies (Faulkender and Wang, 2006 and Dittmar and MahrtSmith, 2007). Section 5.2.1 reports the regression results for the
full sample, including robustness checks. We then divide the full
sample into subsamples by state ownership and re-estimate Eq.
(3), and report results in Section 5.2.2.
5.2.1. Full sample regression results
The full sample regression results are reported in Table 7. Column (1) presents the regression results of Eq. (3), while columns
(2) and (3) provide robustness checks. Our main interests are the
coefcients for the change in cash (DCASHt) and the interaction
terms that contain the change of cash, i.e., DCASHt CASHt1,
DCASHt MLEVt, and DCASHt STATEt All four terms must be
evaluated simultaneously to arrive at the marginal value of cash.
In column (1), DCASHt has a coefcient of 1.2431, suggesting that
one extra RMB added to a rms cash holdings is valued at RMB
1.24, only if the rm has zero cash reserve, zero debt, and zero
state ownership. Both DCASHt CASHt1 and DCASHt MLEVt
have negative and signicant coefcients, suggesting that the marginal value of cash declines with higher current levels of cash and
with higher current leverage. These ndings are consistent with
evidence found in U.S. rms (Faulkender and Wang, 2006 and
Dittmar and Mahrt-Smith, 2007). How the market values an extra
RMB of cash depends not only on the amount of cash a rm already
holds, but also on the amount of debt it holds. For instance, consider two otherwise identical rms: Firm A has high debt and rm
B has low debt. An extra RMB raised is valued more highly in rm B
than in rm A, since an extra dollar raised will more likely be used
to pay interest and principal to creditors in rms with a high debt
levels. Conversely, an extra RMB raised in a low debt rm will more
likely be invested in positive NPV projects or in other productive
activities.
A key prediction by the SBC theory is that state ownership has a
negative effect on the market valuation of corporate cash holdings.
Therefore, we focus on the coefcients of state ownership (STATEt)
and the interaction between state ownership and change in cash
(DCASHt STATEt). As shown in column (1) of Table 7, the coefcient for state ownership (STATEt) is negative and signicant at
the 1% level, suggesting that the level of state ownership has a negative effect on the marginal value of cash. The coefcient of the
interaction term between state ownership and change in cash,
DCASHt STATEt, is 0.3610, signicant at the 1% level, suggesting
that an extra RMB raised is valued at RMB 0.36 higher in rms with
zero state ownership than in rms with 100% state ownership,
ceteris paribus. This nding is consistent with the prediction by
SBC theory that state ownership has a negative effect on the marginal value of cash. A rm with high state ownership has a softbudget constraint and more agency problems. Therefore, managers
in high state ownership rms are more likely to misuse the extra
RMB of cash raised for personal perks or invest in politically expedient projects, as opposed to NPV maximizing projects.
For the average rm in our sample, one extra RMB added to its
cash holdings is valued at RMB 0.96, as shown in Panel B of Table 7.
We use the entire realized change in cash in the econometric
models in column (1) of Table 7, implicitly assuming the entire
change is unexpected. Since the dependent variable is annual
excess stock return, the expected portion of the change in cash
may already be incorporated in the benchmark portfolio return.
288
Table 7
Value of cash regression results: full sample.
(1)
DCASHt
1.2431***
(18.68)
DEBITt
1.4535***
(16.58)
DNAt
0.0011
(0.10)
DINTt
1.0617**
(2.21)
DDIVt
0.3759
(1.37)
DNFt
0.0280
(0.35)
CASHt1
1.2118***
(25.77)
MLEVt
1.6440***
(38.27)
DCASHt CASHt1
0.3384***
(3.20)
DCASHt MLEVt
1.0128***
(5.81)
STATEt
0.2011***
(8.94)
DCASHt STATEt
0.3610***
(3.15)
Constant
N
R2 overall
Mean value
0.1931***
(17.64)
16,154
0.0976
(1)
Port-ave
(2)
ACW
(3)
1.1779***
(15.99)
0.2004***
(7.24)
0.0201*
(1.77)
0.6745*
(1.89)
2.2326***
(7.35)
0.1503**
(2.45)
0.7451***
(14.42)
1.5747***
(34.13)
0.5270***
(4.51)
0.9551***
(5.00)
0.2609***
(10.52)
0.5161***
(4.06)
1.4562***
(17.05)
0.26174***
(7.93)
0.3852***
(26.90)
2.5335***
(3.94)
2.4983***
(6.67)
0.5397***
(5.09)
1.9398***
(31.53)
2.8526***
(49.48)
0.0572
(0.41)
2.1117***
(9.45)
0.12657***
(4.12)
0.9876***
(6.60)
0.1354***
(11.31)
16,316
0.0438
0.0146
(0.99)
16,314
0.0975
(2) Port-ave
Panel B: Calculation of the marginal value of cash

CASHt1
0.1485
0.1485
MLEVt
0.1576
0.1576
STATEt
0.2140
0.2140
Marginal value of RMB 1.00
0.96***
0.84***
(3) ACW
0.1485
0.1576
0.2140
0.90***
The dependent variable is excess return. All variables except excess return, MLEV
and STATE are deated by lagged market value of equity MVEt1. DXt = Xt Xt1.
CASH is cash plus cash equivalents. EBIT is operating income before interest and
taxes. NA is book assets less cash and cash equivalents. INT is interest expenses. DIV
is cash common dividends. NF is net external funds raised, equal to the sum of net
proceeds from equity and debt issuance. MLEV is market leverage, dened as shortterm debts plus long-term debts, scaled by market value of equity. STATE is state
ownership. Subscript (t-1) means the beginning of scal year t. t-Statistics are based
on robust standard errors and are in the parentheses. Model (1) is our base model
which denes change in cash as the realized change in cash from year end (t-1) to
year end t. Models (2) and (3) use alternative denitions of change in cash. Model
(2) uses the benchmark portfolio average as the normal change in cash holdings
(Port-ave), while model (3) uses the Almeida et al. (2004) (ACW) method to
estimate the normal change in cash holdings. The unexpected change in cash is the
realized change minus the normal change. t-Statistics are based on robust standard
errors and are in the parentheses.
Models (1)(3) are evaluated at the mean values of the explanatory variables.
Change of cash, DCASH, takes the value of 1.00, indicating one RMB is added to a
rms cash reserve.
*
**
***
If stock prices quickly reect unexpected new information, excess

stock return should be a function of only the unexpected portion
of the change in cash holdings. In our rst robustness check, we
follow Faulkender and Wang (2006) and use two measures of
unexpected change in cash holdings.
First, we use the average change in cash in the corresponding
benchmark portfolio as the expected change in cash. Thus, our rst
measure of unexpected change is the realized change in cash
minus the average change in cash in the benchmark portfolio.
We re-estimate Eq. (2) and the results, presented in column (2)
in Table 7, are consistent with those in column (1). Our main prediction remains intact that the marginal value of cash declines as
state ownership increases. For the average rm in our sample,

one extra RMB of cash raised is valued by shareholders at 0.84, as
shown in Panel B of Table 7.
For the second measure of unexpected change in cash, we use a
modied Almeida et al. (2004, ACW hereafter) model to estimate
the expected change in cash. The model is as follows:
DCASHi;t
OCFi;t1
b0 b1
b2 Growthi;t1 b3 Sizei;t1
MVEi;t1
MVEi;t1
CAPEXi;t1
DNWCi;t1
DSTDBTi;t1
b4
b5
b6
ei;t
MVEi;t1
MVEi;t1
MVEi;t1
4
where OCF is net cash ow from operating activities, CAPEX is capital expenditures, DNWC is change in net working capital, and
DSTDBT is change in short-term debt, all lagged and scaled by
lagged market equity. Growth is the average sales growth rate over
the previous three years and Size is natural logarithm of book
assets.22 We use a two-step OLS to estimate Eq. (4). The rst step
is to estimate the coefcients in Eq. (4) for each industry, while
the second is to use the coefcients estimated in the rst step to calculate the predicted (expected) change in cash for each individual
rm in that industry. The unexpected change in cash is therefore
the realized change in cash minus the change in cash estimated from
Eq. (4). We proceed to re-estimate Eq. (3) using the ACW measure of
unexpected change in cash holdings, and the regression results are
reported in column (3) of Table 7. These results are largely consistent
with those in column (1), in that the marginal value of cash declines
with higher leverage and higher state ownership. Again, our main
prediction remains robust in that state ownership has a signicant
and negative effect on the marginal value of cash. For the average
rm in our sample, one extra RMB of cash raised is valued at RMB
0.90, as shown in Panel B of Table 7.
5.2.2. State ownership and the value of cash: subsample regression
results
The results from the full sample regressions show that state
ownership has a negative effect on the marginal value of cash, as
shown in Table 7. State ownership ranges from zero to almost
90% in our sample. In the full sample of 16444 rm years, 7410
rm years have zero state ownership, 5824 rm years have between
zero and 50% state ownership, and 3210 rm years have 50% or
higher state ownership. Studies have shown that ownership and rm
value have a nonlinear relation (Demsetz and Lehn, 1985; McConnell
and Servaes, 1990; Wei et al., 2005). The SBC theory predicts that the
relative softness of the budget constraint should manifest itself in
the marginal value of cash across different ranges of state ownership.
To perform this robustness check, we divide the full sample into four
groups. Group 1 consists of 7410 rm years with zero state ownership and Group 4 consists of 3210 rm years with 50% or higher state
ownership.23 The remaining rm years are sorted by state ownership
and then divided about equally into two groups: Group 2 has 2912
rm years with 0.029.3% state ownership and Group 3 has 2912 rm
years with 29.350.0% state ownership. We then re-estimate Eq. (3)
across the four groups of rm years, excluding state ownership
(STATEt) and the interaction term (DCASHt STATEt) as explanatory
variables. These stepwise regressions provide another robustness
check on the SBC prediction concerning the marginal value of cash
22
In the original ACW model, lagged Tobins Q is used instead of sales growth rate,
while DNWC, CAPEX and DSTDBT are scaled by lagged book assets instead of lagged
market equity. Acquisitions are also included in their original model. We do not
include acquisitions in our model due to lack of data.
23
Ayyagari et al. (2010) also use 50% as the cutoff point for state-owned vs nonstate owned rms. Though there is no golden share in China, the government can
often control a privatized rm with less than 50% direct ownership though other
state-controlled institutional owners.
289

Table 8
Regression results of the relation between state ownership and value of cash.

DCASHt
DEBITt
DNAt
DINTt
DDIVt
DNFt
CASHt1
MLEVt
DCASHt CASHt1
DCASHt MLEVt
Constant
Obs.
R2 overall
Mean variable value
(1)
0% state
(2)
029.3%
(3)
29.350%
(4)
P50%
1.4810***
(14.5)
1.4186***
(9.99)
0.0805***
(4.46)
1.2340*
(1.61)
1.0851**
(2.20)
0.3433***
(2.61)
1.5203***
(16.88)
1.9828***
(24.42)
0.3757**
(2.22)
1.4702***
(5.28)
0.1372***
(8.24)
7287
0.0862
1.3160***
(6.93)
0.4654***
(3.61)
0.0327
(1.13)
0.4174
(0.32)
0.24348
(0.26)
0.6085***
(2.84)
1.4085***
(9.56)
2.3108***
(18.54)
0.1743
(0.60)
1.6757***
(3.65)
0.2876***
(8.93)
2881
0.0893
0.9366***
(4.75)
0.5928***
(5.66)
0.002
(0.09)
0.6336
(0.52)
2.0828***
(2.92)
0.2258
(1.04)
1.3016***
(8.85)
1.7466***
(14.89)
0.0878
(0.29)
0.5759
(1.23)
0.1771***
(5.82)
2836
0.1046
0.9790***
(6.50)
1.9538***
(10.03)
0.067***
(2.57)
0.0203
(0.02)
0.6485
(1.27)
0.4983***
(2.49)
0.9999***
(10.33)
1.3159***
(14.27)
0.2564
(1.16)
0.5135
(1.33)
0.1066***
(5.38)
3157
0.1199
(1)
Panel B: Calculation of the marginal value of cash

CASHt1
0.1521
MLEVt
0.1372
STATEt
0
Marginal value of RMB 1.00
1.22***
(2)
(3)
(4)
Diff=(1) - (4)
0.1502
0.1762
0.1374
0.99***
0.1506
0.1769
0.3960
0.82***
0.1368
0.1699
0.6155
0.86***
0.36***
Models (1)(4) are evaluated at the mean values of the explanatory variables. Change of cash, DCASH, takes the value of 1.00, indicating one RMB is added to a rms cash
reserve.
The dependent variable is excess return. All variables except excess return and MLEV are deated by lagged market value of equity MVEt1. DX = Xt Xt1. CASH is cash plus
cash equivalents. EBIT is operating income before interest and taxes. NA is book assets less cash and cash equivalents. INT is interest expenses. DIV is cash common dividends.
NF is net external funds raised, equal to the sum of net proceeds from equity and debt issuance. MLEV is market leverage. Firm years are divided into four groups according to
state ownership in the rm: group 1 in Column (1) has zero state ownership; group 4 in Column (4) has 50% or higher state ownership; the remaining rm years are equally
divided into the middle two groups in Column (2) and Column (3). t-Statistics are based on robust standard errors and are in the parentheses.
*
**
***
across different ranges of state ownership. The subsample regression

results are reported in Table 8.
The main results in Table 8 are consistent with those in Table 7.
Our focus is the marginal value of cash across these four groups.
The coefcients corresponding to change in cash (DCASHt) are
1.48 for Group 1 (column (1)), 1.32 for Group 2 (column (2)),
0.94 for Group 3 (column (3)), and 0.98 for Group 4 (column (4)).
These ndings suggest that, for an all-equity rm (MLEVt = 0) that
currently holds no cash (CASHt1 = 0), an extra RMB of cash raised
is valued at RMB 1.48 in Group 1, RMB 1.32 in Group 2, RMB 0.94 in
Group 3, and RMB 0.98 in Group 4. However, the average rm in
each group is neither an all-equity rm nor a zero-cash rm. For
the average rm in each group, an extra RMB is valued at RMB
1.22 in Group 1, RMB 0.99 in Group 2, RMB 0.82 in Group 3, and
RMB 0.86 in Group 4, as shown in Panel B of Table 8. These results
suggest that one extra RMB is valued RMB 0.36 higher for the average rm in Group 1 (zero state ownership) than for the average
rm in Group 4 (50% or higher state ownership). This difference
is statistically and economically signicant. 24
24
We also conduct robustness checks following the methods in columns (2) and (3)
of Table 7, i.e. using only the unexpected components as change of cash. We repeat
the regressions in Table 8, and our results show that one extra RMB raised is valued
RMB 0.43 (Port-ave) and 0.58 (ACW) higher in zero state ownership rms than in
majority state ownership rms. The results are available in the online appendix
accompanying this article.
6. Conclusions
This study examines the relation between state ownership and
corporate cash holdings in Chinas share-issue privatized rms
from 2000 to 2012. We nd that cash holdings and state ownership
are negatively related, consistent with the prediction of the softbudget constraint theory rst formulated by Kornai (1979, 1980).
This nding is robust after controlling for year effects, rm xed
effects, Chinas split share structure reform, and potential endogeneity. For the average rm in our sample, a 10 percentage-point
decline in state ownership leads to an increase of about RMB 55
million in cash holdings. The level of cash holdings is also negatively related to institutional ownership, possibly due to the fact
that many of the institutional owners are owned or controlled by
various levels of government. We also nd that smaller, more profitable, and higher growth rms hold more cash and that short-term
debts and net working capital are negatively related to cash holdings, suggesting that short-term debts and working capital may be
treated as cash substitutes.
We further examine the relation between state ownership and
the value of cash and nd that the marginal value of cash increases
as state ownership declines. For the average rm in our sample, the
next RMB raised is valued at RMB 0.96 by shareholders. Furthermore, the marginal value of cash in rms with zero state ownership is RMB 0.36 higher than in rms with majority state
290
ownership. We attribute this negative relation to the SBC effect

inherent in state ownership. Chinas share-issue privatized rms
operate in a nancial system largely dominated by state-owned
banks. The majority of debt nancing does not go through the scrutiny of capital markets, but instead comes from banks. On the one
hand, the technocrats or politicians who control the banking sector
have the motives and means to soften the budget constraint of distressed state-controlled rms. On the other hand, self-interested
managers operating under a SBC might misuse the raised funds
for personal perks or invest in politically expedient projects, as
opposed to NPV maximizing projects. This quintessential SBC effect
helps explain the negative relation between the marginal value of
cash and state ownership.
The contributions of this study are as follows. This is among the
rst to examine the causes and consequences of cash holdings in
share-issue privatized (SIP) rms, an important group of rms that
has received inadequate attention in the growing literature on cash
holdings. Our paper is also the rst to employ the well-established
SBC theory in economics to study the effect of state ownership on
the level of cash holdings and on the marginal value of cash. SIP
rms with retained state ownership are more likely to suffer from
the SBC effect and are less nancially constrained, whereas de novo
private rms are likely to have hard-budget constraints (HBC). Our
ndings that the level of cash holdings and the marginal value of
cash are both negatively related to state ownership are new additions to the existing empirical literature.
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Journal of Banking & Finance 48 (2014) 276291

Contents lists available at ScienceDirect

Journal of Banking & Finance

State ownership, soft-budget constraints, and cash holdings: Evidence

motives for holding cash, the need to overcome nancial constraints,

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

important aspect: the privatizing governments usually continue to

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

2. Soft-budget constraint theory and the Chinese nancial

tion helps harden the budget constraint (Lubomir Lizal et al.,

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

rms and total market capitalization. However, the bond market,

ity of cash holdings to bank loans to be high in high state

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

tradable, subject to lockups and other restrictions. As rms sell

3.1. Full sample statistics

To better understand the relation between cash holdings and

Cashi;t cStatei;t bk X i;t ai kt ei;t

The dependent variable, Cashi,t,, is cash holdings measured as cash

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

Panel A: Variable denitions

Panel B: Summary statistics

Value of cash variables

We also control for rm age, rm growth, industry cash ow

in an industry with more volatile cash ows are expected to hold

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

Panel A: Cash holdings and state ownership by year

During the reform (20052007)

After the reform (20082012)

, , indicate signicant at the 1%, 5%, and 10% levels, respectively.

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

negatively related to cash holdings, indicating that they may

two plausible explanations for this. First, institutional investors such

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

Panel A: Regression results

State_dummy Bank loans

Panel B: The marginal effects continuous state ownership

Panel C: The marginal effects

state ownership as a dummy

Cashi;t cStatei;t Bankloansi;t Statei;t Bankloansi;t

where Bankloansi,t is rm is net proceeds from bank borrowings at

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

holdings. These results suggest that the marginal effect of the

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

20052007 are omitted to provide a cleaner comparison of cash

the government changes its ownership stake in a rm based on the

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

The dependent variable is excess annual stock return dened as

We want to test what effects cash levels and debt

levels have on the marginal value of cash in Chinas privatized

5.2. Empirical results

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

Panel B: Calculation of the marginal value of cash

If stock prices quickly reect unexpected new information, excess

state ownership increases. For the average rm in our sample,

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

Panel A: Regression results

Panel B: Calculation of the marginal value of cash

across different ranges of state ownership. The subsample regression

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291

ownership. We attribute this negative relation to the SBC effect

Dahlquist, M., Robertsson, G., 2001. Direct foreign ownership, institutional

W.L. Megginson et al. / Journal of Banking & Finance 48 (2014) 276291