The Impact of Government Intervention on Corporate Investment Allocation and Efficiency: Evidence from China

Abstract

It is well documented in the literature that, to pursue multiple socio-economic objectives of the government, State Owned Enterprises (SOEs) in China tend to overinvest, compared to privately controlled firms. We study the effects of government intervention on the SOEs investment allocations of and the resulting investment efficiency and firm values. China local government officials focus on pursuing economic growth because it strongly affects their political promotions, regional fiscal benefits and social stability. We find that due to local officials’ strong incentives to focus on the short-term economic performance, local government controlled SOEs (local SOEs) tend to invest more heavily in assets with an immediate impact on economic performance and social objectives, such as fixed assets, equity and natural resources assets. They underinvest in R&D, which are riskier and take a longer time, if ever, to be realized. The tendency of local SOEs to invest more heavily in fixed assets, equity and nature resource assets is more significant in provincial regions with stronger government intervention. Our study sheds light on how government intervention would distort corporate investment allocations and lower investment efficiency and firm values.