IFTEKHA HASAN Fordham University and Bank of Finland LIULING LIU Bowling Green State University HAIZHI WNAG Illinois Institute of Technology Trust and Contracting with Foreign Banks: Evidence from China 1 12/3/2015 Conference on China's Financial Intermediation

Motivation Cross-border financial exchanges face significant informational costs. For example,  Home bias in equity investment (Cooper and Kaplanis, 1994; Kang and Stulz, 1997)  Syndicated loan pricing puzzle (Carey and Nini, 2007) Mechanisms to deal with information problems  Local sources of information  Importance of Institutions, including legal systems 12/3/2015 Conference on China's Financial Intermediation 2

Motivation (cont’d) Social trust and information processing  Social trust changes the incentives of economic agents and creates a cooperative environment (Algan and Cahuc, 2010)  Trusting or trustworthiness is a crucial determining factor when individuals choose to act or react toward others (Hardin, 2002)  Social trust tend to greatly influence the way people release and process information (Cook, 2001; Hardin, 2002) 12/3/2015 Conference on China's Financial Intermediation 3

Research questions In this study, we intend to relate social trust to cross-border syndicated loan contractual terms  Social trust and foreign loan contracts  Cost of bank loans  Fees in loan contracts  Non-price terms in loan contracts (i.e., maturity and collateral) 12/3/2015 Conference on China's Financial Intermediation 4

Literature review Lending at distance (cross-border syndicated loans)  Interest rate spreads vary across different regions (Carey and Nini, 2007; Houston et al., 2007)  Informational costs (Mian, 2006)  Negotiation costs (Degryse and Ongena, 2007)  Enforcement costs in the events of default (Haas and VHoren, 2013) 12/3/2015 Conference on China's Financial Intermediation 5

Literature review (cont’d) Social trust, as a form of social capital, plays an important role in economic transactions  Social trust facilitates economic growth (Algan and Cahuc, 2010)  Social capital and financial development (Guiso, 2004)  Social trust and international trade (Guiso et al., 2009)  Social trust and equity investment (Guiso et al., 2008)  Social trust and selection of money managers (Gennaioli et al., 2015)  Trust and crediquality of financial reporting (Jha, 2013) 12/3/2015 Conference on China's Financial Intermediation 6

Literature review (cont’d) Social trust: Chinese evidence  Trust and regional economic development (Zhang and Ke, 2002)  Social trust and foreign high-tech companies’ investment (Ang et al;, 2014)  Provinces with high social trust scores attract more foreign investments in high-tech industry  Foreign firms located in high-social-trust regions conduct more R&D, higher more R&D personnel and are more likely to establish JVs with local partners  Social trust and trade credit (Wu et al., 2014)  Firms located in high-social-trust regions use more trade credit from suppliers, extend more trade credit to customers and collect receivables and pay payables more quickly 12/3/2015 Conference on China's Financial Intermediation 7

Literature Review (Cont’d) Institutions  Formal institutions (China evidence)  Enforcement of property rights significantly affect firm reinvestment decision (Cull and Xu, 2005)  Enforcement of intellectual property rights impacts firm financing and investment decision (Ang et al., 2015) 12/3/2015 Conference on China's Financial Intermediation 8

Literature Review (Cont’d) 12/3/2015 Conference on China's Financial Intermediation 9 Institutions  Informal institutions (China evidence)  Financing channels and governance mechanisms based on reputation and relationships support the growth of the private sector (Allen, et al., 2005)  In contrast, firms with formal bank financing are associated with faster growth, compared to firms with informal financing (Ayyagari, et al., 2010)

Additional research question Social trust, as an important component of social capital, can function as informal institution We ask one additional research question  Does social trust complement or substitute the role of formal institutional development in terms of borrowing cost? 12/3/2015 Conference on China's Financial Intermediation 10

Data and Sample Dealscan and CSMAR  177 loan facilities from 1998 to 2013 Dependent measures  All-in-spread-drawn (AISD)  Total fees  Upfront fee  All-in-spread-undrawn (AISU) including commitment fee and facility fee  Non-price terms  Collateral  Maturity 12/3/2015 Conference on China's Financial Intermediation 11

Measures Main explanatory variables  Trust1  Survey conducted by the “Chinese Enterprise Survey System in 2001  Mutually trustworthiness among corporate managers for a particular province  Trust2  China General Social Survey (2003)  General trustworthiness of strangers by residents in a particular province  Blood  Blood donation per capita in a province 12/3/2015 Conference on China's Financial Intermediation 12

Measures (cont’d) Other control variables  Firm size  Book leverage  Profitability (ROA)  Sales growth rate  Loan size 12/3/2015 Conference on China's Financial Intermediation 13

Baseline regression: trust and AISD 12/3/2015 Conference on China's Financial Intermediation 14

Other price terms: fees 12/3/2015 Conference on China's Financial Intermediation 15

Nonprice terms 12/3/2015 Conference on China's Financial Intermediation 16

Interaction effect of trust and instituions 12/3/2015 Conference on China's Financial Intermediation 17

Take away… Social trust is negatively correlated with cost of bank loans  The negative effect is more pronounced for syndicated loans with local partner Social trust is negatively correlated with fees  The negative effect is more pronounced for upfront fees Social trust is negatively correlated with the likelihood of collateral usage but insignificantly related to loan maturity The effect of social trust is weaker whether there exists better formal institutional development 12/3/2015 Conference on China's Financial Intermediation 18