Eat, Drink, Firms and Government: An Investigation of Corruption from Entertainment Expenditures of Chinese Firms

Abstract

Entertainment and Travel Costs (ETC), an expenditure item in standard accounting books of firms in China, amount to about 20% of total wage bills in a sample of 3470 Chinese firms. Using a detailed dataset of these firms, we analyze the composition of ETC and effects of ETC on firm performance. We develop a simple model of managerial decisions on the amount of entertainment expenditures to spend on strengthening relational capital with suppliers and clients, bribing government officials, and private consumption. This model allows us to identify components of ETC by examining how they should respond to different environmental variables. We find strong evidence that firms' ETC compromise a mix that includes expenditures on government officials both as grease money and protection money, expenditures to build relational capital with suppliers and clients, and managerial private consumption. Overall, ETC have significantly negative effects on firm performance, but their negative effects can be much less pronounced when their marginal returns are higher, particularly, under severe government expropriation and when the quality of government service is very poor.