# Financial constraints and corporate bankruptcy risks in China: The buffer role of cash holdings

## TL;DR

This paper examines how cash reserves help Chinese firms avoid bankruptcy amid financial constraints.

## Contribution

The study reveals that cash holdings act as a buffer against bankruptcy risk for financially constrained firms in China.

## Key findings

- Higher financial constraints increase corporate bankruptcy risk in China.
- A 1% increase in cash holdings raises the Z-score by 0.37 points, reducing bankruptcy risk.
- Cash reserves mitigate the adverse effects of financial constraints on financially constrained firms.

## Abstract

Corporate bankruptcy risk in China is increasingly driven by structural credit discrimination and a systemic financial mismatch. This study investigates the impact of cash holdings and financial constraints on corporate bankruptcy risk in China. We employ the Two-step system Generalized Method of Moments (GMM) to analyze an unbalanced panel of 32,081 annual observations from listed firms in China, spanning the period from 2010 to 2023. Our findings indicate that higher financial constraints increase bankruptcy risk, as a one-point rise in the SA index reduces the Z-score by 4.26 points, supporting Market Timing Theory. Conversely, cash holdings serve as a powerful protective buffer; a 1% increase in cash holdings raises the Z-score by 0.37 points, supporting the Precautionary Savings and Trade-off theories. Furthermore, our results highlight the buffer role of cash holdings for financially constrained firms, where higher cash reserves mitigate the adverse effects of financial constraints on bankruptcy risk. Our main findings remain robust after employing alternative bankruptcy risk proxies, firm size-based, and exchange subsamples. These findings provide valuable insights for financial managers and policymakers, highlighting the importance of effective liquidity management and credit accessibility in mitigating corporate distress in emerging markets.