Institutions, Ownership, and Finance : The Determinants of Profit Reinvestment Among Chinese Firms

Johnson, McMillan and Woodruff (2002) examine the relative importance of property rights and external finance in several Eastern European countries, and find property rights to be overwhelmingly important, while external finance explains very little of firm reinvestment. McMillan and Woodruff (2002) further conjecture that as transition moves along, market-supporting (financial) institutions should become more important. This paper re-examines these issues in the context of China in 2002, a point at which the transition had moved quite far. We also find that secure property rights are a significant predictor of firm reinvestment. However, in line with the McMillan-Woodruff conjecture, we find that access to external finance in the form of bank loans is also associated with more reinvestment. Following Acemoglu and Johnson (2003) we separate our proxies for the security of property rights into two groups: those measuring the risk of expropriation by the government and those measuring the ease and reliability of contract enforcement. Whereas those authors' cross-country results suggest that risk of expropriation is the more severe impediment to economic development, ours indicate that both expropriation risk and contract enforcement play a role in Chinese firms' reinvestment decisions. We also find that another aspect of property rights, the extent of private ownership is associated with greater reinvestment. At China's current stage of development, it appears that expropriation risk, contract enforcement, access to finance, and ownership structure all matter for reinvestment decisions. There is also some evidence that access to finance and government expropriation affect small firms more than large ones