Corporate Performance and Governmental Favoritism in Administrative Restructuring: Evidence from a Natural Experiment in China

Abstract: This paper outlines the extent to which local governments in China influenced corporate performance during its period of administrative restructuring. In light of endogenous problems concerning local governments’ favoritism against enterprises of different ownerships, we adopt the DID method and treat an exogenous administrative restructuring, which is the “Annexation of suburban counties by cities,” as a natural experiment. Applying 140294 panels of corporate data from the Chinese Industrial Enterprises Database for the period 1999 to 2009, we find that compared to the enterprises located in the control group, the enterprises within the counties and cities that are involved in administrative restructuring show lower levels of performance. Meanwhile, the negative impact is stronger when administrative restructuring is actively applied by prefectural-level cities for bettering local economies than when it is designed based on provincial interests. Additionally, we identify the causal mechanism between worse-off corporate performance and change in governmental favoritism: there is reduced inter-governmental transfer after the “Annexation of suburban counties by cities” Reforms reduced governmental favoritism, thereby decreasing local infrastructure investment, which also reduced subsidies and increasing taxation for enterprises. In conclusion, because of their institutional dependence on local governments, enterprises suffer the most when local administrative structures are changed, which implies an inherent problem to governmental favoritism. Keywords: Corporate Performance; Governmental favoritism; Annexation of suburban counties by cities; Administrative Restructuring