Creditor Litigation,Cash Holdings And The Value Of Cash

“Ruling the country according to law”is an important strategic issue at present.In China’s development,the law is always the most important tool for governing the country,and good law is the prerequisite for good governance.The 19^th People’s Congress proposed that comprehensively advancing the rule of law is one of the country governance strategies in the new era.Emphasizing the trinity of“rule by law,government by law,and society by law”in the construction of China under the rule of law,the goal of China in the construction of the rule of law is positioned at“scientific legislation,strict law enforcement,fair justice,and law abiding by the people”,forming a complete legal system,promote the modernization of national governance systems and capabilities.China’s current series of judicial reform steps will undoubtedly affect the development of the capital market,as well as the behavior and decision-making of majority of participants in the capital market.Based on the background of China’s ongoing series of judicial reforms,this article focuses on whether the enforcement of legal proceedings will affect the financial behavior of enterprises.China is an emerging market.The institutional construction of capital markets and the internal governance mechanism of firms are quite different from those of western developed countries.In China,highly centralized control structure is a common phenomenon.The interest conflict between shareholders and creditors is a key agency issue.Litigation has become a common phenomenon in China’s capital market.Judging from the amount,the creditor litigation claim amount is the largest and the most common.According to the principle of materiality,it is more meaningful to choose the case of debt litigation for research.Therefore,we believe that the chinses context provides a rare opportunity to study the mechanism and effects of debt governance.Firstly,creditor litigation satisfies the description of control rights distribution in financial contract theory.The debt contract gives creditors the power.When the debtor defaults,the creditor can protect its rights and interests by speeding up the payment,recovering the collateral and refusing further loans.These contractual remedies allow creditors to directly or indirectly influence corporate policies.Secondly,creditor litigation provides a quasi-natural experimental research for this article,which can more accurately identify the mechanism that creditor litigation affects corporate behavior.This article locates the foothold of the governance mechanism for examining creditor litigation at the cash assets of the firms.The reason is as follows:First,the governance mechanism of litigation is a form of external governance.Its ultimate purpose is to alleviate the agency problem of the firms.The most fundamental criterion for determining whether a litigation can play the debt governance mechanism is to see whether the creditor lawsuit can alleviate the agency issues among shareholders and creditors.Second,cash is a special asset for firms.Based on agency issues,liquid assets are most easily converted into the private property of management and controlling shareholders at a lower cost.In countries with more agency issues,firms will hold more cash holdings.Compared with external financing,the management is more inclined to accumulate internal funds.With the large accumulating of internal funds,the management will use funds for self-interest.Of cash holdings will lead to more value-acquisition mergers and acquisitions and capital investments.Whether it is through on-the-job consumption or over investment,it is the easiest asset to satisfy the self-interest behavior of shareholders.We believe that whether debt governance can play a role in alleviation corporate agency issues could be directly reflected in changes in corporate cash holdings behaviors.This article manually collected the creditor litigation data of listed companies on the Shenzhen Stock Exchange and the Shanghai Stock Exchange from 2003 to 2015 by reading the information of firm’s annual reports.We found,firstly,regarding the short-term behavior of the firm’s cash holdings,in the event year of the respondent,the firm’s cash holdings were at the lowest point,that is before the company was sued,the cash holdings showed a downward trend,until the year of the lawsuit,the cash holdings reached the lowest point,with the occurrence of lawsuits,the firm’s cash holdings began to increase.Further research found that after being sued,the firm improved asset liquidity by reducing expenses and disposing of asset.Secondly,in terms of long-term investment behavior of firms,after the lawsuit,the firm will change the management to improve the internal governance,which not only eases internal financing constraints,but also significantly inhibits the over-investment behavior or the firm,which illustrates the external governance mechanism of creditor litigation can restrain the over-investment of shareholders,and the creditor can play the role of outside governance.Thirdly,the creditor litigation ultimately improved the value of cash of the firm.In general,this article finds that the governance effect of creditor litigation can affect the short-term and long-term behavior of firms,and ultimately improve corporate value.Depending on the types of creditors,the types of litigation involved,the level of internal control,the degree of analyst attention,the concentration of equity,and the level of rule of law in the region where the firm is located,the governance effect of creditor litigation are also different.Specifically,when the internal governance level of the firm and the external monitoring environment is weak,the governance effect of the creditor litigation is more significant.Meanwhile,the more important the creditor’s position in the firm,the more significant the governance effect of creditor litigation.Based on the results of this study,we believe that litigation is an extreme method of protecting creditors’rights by the law,and can supplement governance when other internal constrains and external supervision are difficult to play a governance role.In general,in the context of China’s emphasis on“ruling the country according to law”,this article examines the governance effect of litigation in China’s capital market based on the perspective of creditors,explains the law’s governance mechanism for firms,and provides the experience evidence of legal protection of creditor rights.