Why do the enterprises engage in inefficient investment in China? Evidence from the government’s grabbing hand

This paper theoretically and empirically explores the reason why Chinese enterprises engage in inefficient investment from the government’s grabbing hand perspective on a large sample of 8501 firm-year observations between 2003 and 2011. The results suggest that influenced by the grabbing hand of local officials, private enterprises exhibit significantly higher investment distortion and inefficiency in terms of overinvestment and underinvestment than the enterprises controlled by the governments at all levels. Moreover, the negative association between the government’s grabbing hand and the investment efficiency of private enterprises shows no signs of easing over time. Further analyses reveal that underinvestment and overinvestment, respectively, adversely affects one year ahead future market value and return on assets of private enterprises, but there is little evidence indicating that underinvestment and overinvestment have a negative impact on one year ahead future market value and return on assets of the enterprises controlled by the governments at all levels. Finally, I find that while the government’s grabbing hand also imposes a significantly inverse effect on one year ahead future market value and return on assets of the enterprises, yet it doesn’t further exacerbate the adverse impact of underinvestment and overinvestment on the market value and return on assets of the enterprises in the following year. The policy implications of this paper is that the Chinese central government should rethink profoundly its rule for selection and promotion of local officials based on relative economic performance under the political centralization, and fundamentally improve the governance structure of local governments.