Internal Capital Markets and the Transmission of Exchange-Rate Shocks : Micro Evidence from Chinese Customs Data

Liquidity-constrained large shareholders often reallocate capital within business groups to finance their own projects, imposing credit constraints on other group members. Using microdata from Chinese customs, we study the impact of this negative externality on the transmission of exchange-rate shocks through exporters' pricing behavior. We exploit a mandatory ownership-structure reform in China that differentially increases group owners' borrowing capacity through a collateral channel and, as a result, reduces their incentive to use intragroup trade credit to tunnel resources out of publicly listed firms. Exporting subsidiaries of less tunneled public firms stabilize local-currency export prices more in response to exchange-rate fluctuations in the destination-market currency. Our estimate indicates an exporting subsidiary will price to market 45%-50% less if large shareholders tunnel 1% of the public firm's total assets. Subsidiaries also have access to less credit from tunneled firms