Does Government Control Always Reduce Firm Value? Theory and Evidence from China

Purpose The goal of this paper is to investigate the relationship between government control and firm value in China. Design/methodology/approach Government might extract social or political benefits from a state-controlled firm, thus decreases firm value. However, government’s monitoring on firm management reduces managers’ agency problem, which increases firm value. We first build a game-theoretic model to prove the existence of optimal government control given these two roles of government, and we then employ the OLS regression method to test the theory predictions using the length of intermediate ownership chains connecting the listed state-owned enterprises to their ultimate controllers as the measure of government control. Findings We find that firm values first increase then decrease as government control weakens. Moreover, we find that government usually retains a stronger control over state-owned enterprises than the optimal level. In addition, we show that government control can be further weakened in firms with good corporate governance mechanisms, which serve as a substitution of government monitoring. Social implications Our results demonstrate that government control in China is still a necessary but costly mechanism to mitigate agency costs, especially when corporate governance system is underdeveloped. Originality/value We identify the substitution effect between government control and corporate governance using a unique measure of government control.