Social trust and corporate financial asset holdings: Evidence from China

This study examines the impact of social trust on firms' holdings of non-currency financial assets using a large sample of firms in China's real sector. We find that firms in regions of the high social trust hold fewer financial assets, consistent with the notion that credibility in high-trust regions reduces information asymmetry and transaction cost among market participants. This leads to better access to formal and informal financing and higher profitability for the real economy, eventually depressing firms' financial asset allocations. We also find that the negative effect of social trust on financial asset holdings is more prominent for private firms and firms with weak internal monitoring from large shareholders, suggesting that corporations rely more on trust in these cases; it is less pronounced when firms are in regions with good legal systems, proving social trust to be a substitute for formal institutions.