A Tale of Two Sectors : Implications of State Ownership Structure on Corporate Policies and Asset Prices in China

We investigate the impact of state ownership structure on asset prices and corporate policies. By primarily focusing on China's corporations, we show that the relationship between expected returns and capital investment varies significantly across state owned enterprises (SOE) and private owned enterprises (POE). A portfolio that longs low investment and shorts high investment firms earns an average annual excess stock return of 5% in the SOE sector. In contrast, there is no relationship between investment and expected returns in the POE sector. We show that the difference in the link between expected returns and investment across SOE and POE firms is driven by their differential exposures to the debt issuance shocks, which captures the monetary supply shocks in China. As SOE firms have easier access to bank loans, the high investment firms in the SOE sector are more able to raise debt despite that debt supply is shrinking, and hence they are less risky. We develop a dynamic model with SOE and POE firms facing different frictions in debt markets. The economic mechanism emphasizes that heterogeneous access to the debt market is an important determinant of equilibrium risk premiums across sectors with different state ownership