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Security Regulations, Access to Capital Markets, and Firm Performance: Evidence from China

In this paper we study the economic consequences of the security regulation in China that requires firms to meet certain profitability benchmark before they can apply for rights offerings or seasoned equity offerings (SEOs). We find that due to the lack of access to the equity financing market, firms with high growth opportunities but low profitability underperform firms with similar growth opportunities and true profitability but engage in earnings management to obtain SEOs. In contrast, we find that firms with high profitability but low growth opportunities underperform when they obtain additional equity financing from SEOs. Additional analyses indicate that compared to SEO firms with low growth opportunities, those with high growth opportunities invest more on capital expenditures and are less likely to experience tunneling. Moreover, we find that investors have the ability to distinguish between firms with high growth opportunities from other without. Overall, our analyses indicate significant cost of the regulation.