Discrimination against the private sector by China's state-owned banks has made splashing out on entertaining vital to the survival of many of the country's smaller firms, new research has revealed.
Small and medium-sized private companies have little choice but to wine and dine key contacts if they hope to endure, the study suggests, so much so that the average Chinese SME spends almost seven per cent of their total assets on building up "social capital" – the web of relationships that helps them thrive.
The study, by the Globalisation and Economic Policy Centre, based at the University of Nottingham in the UK, highlights the continuing importance of "guanxi" – informal networking – in the sphere of Chinese business.
But it also exposes the problems faced by the nation's privately-owned SMEs.
Study co-author Alex Newman said: "Chinese companies are clearly influenced by the social and business relationships they have. These relationships might be with executives at other firms, bank officials or government officials.
"They allow companies to gain preferential access to a whole host of scarce information and resources, including financial capital.
"This is especially important when China's state-owned banks still discriminate against the private sector in their lending practices.
"But informal financing isn't necessarily appropriate if China wants to develop world-class private firms than can compete globally.
"A generous expenses account can only get you so far, and in the long term policymakers need to improve access to bank financing."
The research examined data from annual accounting reports filed with the National Bureau of Statistics by 65,551 firms from 2000 to 2006.
Newman, a Lecturer in International Business at Nottingham University Business School, Ningbo, China, described the amount of entertainment expenditure as "significant".
He explained that the problem stemmed from the fact that until 1998, when the constitution was changed, state-owned commercial banks were instructed to lend only to state-owned enterprises.
"Even now banks still consider private enterprises riskier than their public-owned counterparts – and the problem is even bigger for SMEs," he said.
"This is why an SME's entertainment expenditure represents such a crucial investment in building business and social relationships."
The study concluded that for many SMEs social capital effectively acts as a substitute for fixed assets as security for short-term lending.
By contrast, firms that are able to access long-term financing generally have less need to splash out on meals, gifts and other expenses.
The research warns such obvious and widespread reliance on guanxi might not benefit Chinese SMEs or the country itself in the long term.
Co-author Alessandra Guariglia, a Professor of Financial Economics at Durham Business School, said: "It's right to say senior managers need to recognise the importance of building relationships to enhance firm performance.
"Without adequate social capital, SMEs may face huge difficulties in obtaining the short-term financing so vital for them to survive their early years. But managers should also recognise the consequences of becoming over-reliant on these relationships, as well as what they might entail."
Whatever its informal benefits, fellow author Jun Du, a Lecturer in Economics at Aston Business School, agreed that Guanxi can't replace effective formal financing mechanisms for businesses.
"Guanxi confirms numerous benefits on firms, regardless of their capabilities, but is reinforced by implicit rules of reciprocity and obligation," he said.
But he warned that while 'wining and dining' might have supported the growth of Chinese SMEs until now, it may not be enough to do so in the future.