Local government debt and corporate cash holdings: Evidence from China

Abstract

This study, based on Chinese data, examines how local government debt (LGD) affects the cash holding policies of local firms. We find that a higher LGD significantly increases cash holding levels of local firms, mainly by impeding their access to external financing, particularly bank loans, prompting a precautionary cash buildup. Heterogeneous analyses suggest that the impact of LGD on cash holdings is more pronounced for firms without financing privileges (non-state-owned enterprises and those without political connections), firms located in provinces with a stronger non-state-owned economy, and firms located in cities with more restricted bank credit supply. Additionally, a higher LGD leads to slower adjustments of cash holdings toward target levels and higher market value of excess cash holdings for local firms. These findings provide new insights into the economic implications of increased government debt and contribute to our understanding of corporate cash holding policies.