Working Paper: NBER ID: w29775
Authors: Zhiguo He; Guanmin Liao; Baolian Wang
Abstract: We study the impact of government-led incentive systems by examining a staggered reform in the Chinese state-owned enterprise (SOE) performance evaluation policy. To improve capital allocative efficiency, in 2010, regulators switched from using return on equity (ROE) to economic value added (EVA) when evaluating SOE performance. This EVA policy adopts a one-size-fits-all approach by stipulating a fixed cost of capital for virtually all SOEs, ignoring the potential heterogeneity of firm-specific costs of capital. We show that SOEs did respond to the performance evaluation reform by altering their investment decisions, more so when the actual borrowing rate was further away from the stipulated cost of capital. Our paper provides causal evidence that incentive schemes affect real investment and sheds new light on challenges faced by economic reforms in China.
Keywords: State-Owned Enterprises; Incentive Systems; Capital Allocative Efficiency; Economic Value Added
JEL Codes: G31; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| EVA policy adoption (G52) | increased investment among SOEs (H54) |
| standard deviation increase in interest rates (approximately 33 percentage points) (E43) | increased investment among SOEs (H54) |
| EVA policy adoption (G52) | changes in investment behavior based on borrowing rates (E43) |
| interest rates below 3.5% or above 9.5% (E43) | reduction in return on equity (ROE) (G32) |
| EVA policy adoption (G52) | implications for capital allocative efficiency (D61) |
| EVA policy adoption (G52) | exacerbate over- and under-investment issues at individual firm level (G31) |