Financial institution shareholding and corporate innovation: Evidence from China

Existing literature on bank-firm ties mainly focuses on the financial decisions of non-financial firms when they are fully or partially owned or controlled by financial institutions (e.g., commercial banks, investment banks, insurance companies). However, there is an alternative pattern of tie between financial institutions and firms; that is, a non-financial firm invests a significant amount in banks or other financial institutions, which we refer to as financial institution share-holding (FIS). Little is known about how the investment decisions of non-financial firms are shaped by this FIS. We fill this gap by investigating the impact of FIS on corporate innovation in China. Our empirical results show that FIS impedes corporate innovation. Using a mediation model, we find that the negative effect of FIS on corporate innovation is brought about through managerial agency conflict. We also show that this negative impact is more pronounced among CEOs with shorter decision horizons, firms with greater analyst coverage, and firms whose stocks are more liquid. Furthermore, we find that FIS simultaneously results in the under-hiring of the highly educated workers critical to corporate innovation. Overall, our findings indicate that FIS causes firms to lose growth potential by exacerbating managerial agency conflict.