A Tale of Three Channels: The Real Estate Boom and Firm Investment in China

Laura Xiaolei Liu is Professor of Finance and Accounting at Guanghua School of Management, Peking University. She received her PhD from University of Rochester. Her PhD thesis was awarded the Best Corporate Finance Paper Award at Western Finance Association conference and the Best PhD Paper Award at Southwestern Finance Association conference. Her research interest is capital markets and empirical corporate finance. Her work has been published in leading academic journals including Journal of Political Economy, Journal of Finance, Review of Financial Studies, Journal of Monetary Economics, and Management Science. Before joining Guanghua, Professor Liu was an associate professor with tenure at Hong Kong University of Science and Technology. In 2011, she visited Cheung Kong Graduate School of Business where she taught Private Equity Financing.

We analyze how the ongoing real estate boom in China affects firm investment. In addition to the widely documented collateral channel, we also uncover two other channels: the speculation channel—rapidly rising commercial and residential land prices induce land-holding firms, which have access to financing, to buy more land; and the crowding out channel—the increased land investments by land-holding firms crowd out not only their non-land investments and innovation activities but also bank financing to non-land-holding firms. Netting out these channels, a 100-percent increase in commercial land prices leads to an estimated loss of 9.5 percent to aggregate TFP due to misallocation of capital. Our findings caution a widely-held view that real estate booms help to mitigate firms’ financing constraints and thus boost the economy by stimulating firm investment.