Local government fiscal stress and corporate risk-taking: Evidence from a quasi-natural experiment in China

Abstract

This study investigates the effects of local government fiscal stress on corporate risk-taking and its potential mechanisms by employing a difference-in-differences (DID) approach in the context of a unique pilot program in China to replace the business tax (BT) with the value-added tax (VAT). Using a sample of Chinese listed firms from 2009 to 2015, this study finds that (1) local government fiscal stress has a causal and negative effect on corporate risk-taking; (2) this effect is more pronounced for firms in regions with higher tax intensity, privately owned firms, firms with lower sales growth, and service industry firms; and (3) to mitigate fiscal stress, local governments issue more government debt, strengthen tax enforcement and sell more land, which increases external financing constraints, decreases internal cash flow and intensifies corporate financialization, respectively, leading to a decline in corporate risk-taking. The above findings offer a rationale as to why higher local government fiscal stress might be associated with lower levels of corporate risk-taking.