Does social trust restrain firm financing violations? Evidence from China

We use a sample of Chinese firms to examine the impact of social trust, as an informal institution, on firm financing violations. Our findings suggest that when a firm is located in a region with high social trust, it commits fewer financing violations than those committed by firms in a region of low social trust. The results are robust for alternative measures of financing violations (fraudulent activities when issuing new shares, changing the use of new funds to uses other than the stipulated purposes, or illegally using third‐party loan guarantees), social trust, and after using instrumental variables estimation to account for endogeneity. Additional analysis suggests that the impact of social trust on restraining financing violations is more pronounced for firms having lower interest costs, facing low industry competition, located in high marketisation regions, and having good internal control. The findings show that the impact of social trust on financing violations is moderated by the economic reality of the firm (interest costs and competition), the formal institutional environment (level of marketisation), and the internal governance of a firm (internal control).