Chinese Tango: Government Assisted Earnings Management
School of Economics and Management, Tsinghua University
Chi-Wen Jevons Lee
A.B. Freeman School of Business, Tulane University
School of Economics and Management, Tsinghua University
School of Business and Management, HKUST
Correspondence: Chi-Wen Jevons Lee, A.B. Freeman School of Business, Tulane University, New
Orleans, LA, 70118-5669, USA Jevons.firstname.lastname@example.org, Tel: (504) 862-8485
ABASTRACT: In a Socialist market economy like China, the relations between
various layers of government and state-owned enterprises are tangled. When the
Socialist system embraces the market economy, it creates many facets of interest
conflict and goal incongruence. This paper describes the collusion between local
government and state-owned enterprises in conducting earnings management to
circumvent central government regulation, a phenomenon known as Chinese Tango.
Our study shows that local government actively participates in earnings management
of the listed firms by providing fiscal transfers. The primary purpose of this
government-assisted earnings management is to assist the firms to manage accounting
earnings to meet the regulation stipulated by the central government.
Keywords: Local taxation; fiscal transfers, rights offering; earnings management;
returns on equity (ROE)
Data Availability: Data are available from sources identified in the paper
Transforming socialist system into a market economy has been China’s most important
policy since 1978. To facilitate market-based corporate financing, China established stock
markets in Shanghai and Shenzhen.1 In a “socialist market economy,” the relations between
the state-owned enterprises (SOE) and various layers of government are entangled, with many
facets of interest conflict and goal incongruence. The purpose of this paper is to study the
three-person game of central government, local government and SOE related to the issue of
earnings management in the process of corporate financing in stock market. This study
provides an interesting case of earnings management by real transaction and casts light on the
intricate functioning of the emerging stock market in China.
In the three-person game, the central government sets the fiscal policy and the stock
exchange regulation. The local government which has direct control over most SOEs
implements the policy of taxation and fiscal transfers. The SOEs need to meet the stock
exchange regulation for market listing and rights offering. The financial and operational
performance of listed SOE can affect the regional governor’s performance. The regional
governors and SOE managers may collude. The central government is forced to adjust policy
and regulation to deal with the gaming by regional governors and SOE managers. The
three-person game is the primary driving force behind various major events in the Chinese
The Shanghai Securities Exchange (SHSE) was officially opened in December 1990, followed by the Shenzhen
Securities Exchange (SZSE) in July 1991. Under the socialist planned economy, the SOE’s financial
resources were rationed by government agency. The inefficiency of this ration scheme was the major
cause for China’s economic failure in 1960s. Establishing an open financial market and letting market
mechanism guide the production/investment decisions are the core of economic reform in China.
Before 1986, the SOE was part of gigantic government bureaucracy with annual funding
allocated by the government. The establishment of the stock market came with shutting off
the government funding spigot. As a consequence, the newly listed SOE faced severe funding
shortage. Moreover, the SOE managers, who have neither full authority nor ultimate
responsibility for the firm, viewed the stock market as a no-cost funding source. Some
unscrupulous SOE managers even took advantage of the privilege of stock market financing
as a vehicle for self-enrichment. For shareholder protection, the CSRC (Chinese Securities
Regulation Committee) issued a series of regulations on the qualification of initial public
offering and right offering. The most rigid regulation is the Minimum ROE Requirement.2 It
led to rampant earnings management among Chinese listed companies.3
Earnings management is a universal phenomenon. Most researches apply a model of
two-person game such as firm vs government or manager vs shareholders to analyze the
possible motives behind earnings management. 4 The unique institutional setting of
developing a market infrastructure from a socialist system in China provides an interesting
case of three-person game. The Chinese stock market was created as a partial replacement for
fiscal funding to SOEs. We find that local government colludes with SOEs in conducting
earnings management to circumvent central government regulation, a phenomenon known as
IPO requires two years of profitability. The requirement for rights offering kept on changing, reflecting CSRC’s
effort to protect shareholders against management expropriation. Rights offering required two years of profits after
December 1993, three-year average ROE not below 10 percent after September 1994, ROE not below 10 percent
for each of previous three years after January 1996, and three-year average ROE not below 10 percent and ROE
not below 6 percent for each of previous three years after March 1999. For regulations on IPO, see Aharony, Lee,
and Wong (1999). For regulations on rights offering, see Lee and Song (2002) and Lee and Cao (2002).
3 Aharony, Lee, and Wong （1999) found earnings management in IPOs. Jiang (1998) documented the
See Schipper (1989), Healy and Whalen (1999), and Dechow and Skinner (2000) for details.
Chinese Tango. The tangling relationship among various layers of government and SOEs arose
naturally from the socialist planning system. Very often, the local government is the primary
supervisor of the listed SOE. However, as all regional governors compete to attract financial
capital for developing their jurisdictions, the supervisor colludes with their charges to
circumvent the rules set in Beijing. The local government provides SOEs with fiscal subsidies
against the legal regulations to help local listed companies conduct earnings management to
meet the required ROE for various financial transactions in stock market.
The remainder of the paper proceeds as follows. Section 2 describes the institutional
background of the emerging capital market in China. Section 3 reviews the unique
characteristics of earnings management in China. Section 4 investigates the practice of
taxation preference and fiscal subsidies by local government to listed companies. Section 5
studies the three-person game of Chinese Tango. The summary and conclusion are presented
in Section 6.
2. INSTITUTIONAL SETTINGS
SOE Reform and Stock Market Development
Beginning in 1978, a series of reform were adopted to revive the moribund SOE in
China. In 1979, SOEs were allowed to retain part of their profits for future development. Then
the fiscal budget was replaced in 1980 by bank lending as the major financing source for
SOEs. In early 1990s, the average debt/asset ratio of SOEs reached the unsustainable 80%. A
tiny fluctuation in operation income was enough to drive most SOEs toward bankruptcy. By
1990, the whole China was awash with bad debts. The Chinese stock market was developed
as a vehicle to transfer the government’s responsibility of financing SOEs to financial
intermediaries in an open market and to grant SOEs autonomy as an independent economic
and legal entity. Loosening up the entangled relationship between the government and the
SOE lies in the core of China’s economic reform.5
Shanghai Securities Exchange was established in November 1990, with eight firms
initially listed (Feng, 1997). Most listed companies were restructured from old SOEs. The
traditional close ties between governments and firms under the planned economy lingered on
in spite of restructuring. Government still intervened in the enterprises management and
enterprises often relied on the government for special treatments. Listed SOEs are usually the
largest companies in their locales and have great influence on the local economy. We observe
a mix of principal-agent and symbiotic relations between the regional governors and SOE
managers and between the local government and SOEs.
Insert Table 1
Table 1 illustrates the ownership of listed companies in China. Essentially all listed
companies were transformed from SOEs. Provincial government or metropolitan city
government owns about 85% of listed companies. In these “local” companies, the local
government either directly holds the shares through the State Asset Investment Management
Company, or indirectly controls the listed company through a parent-SOE. About 1%-4% of
listed firms are owned by the central government through a parent-SOE. These firms are
mostly natural monopolies such as telecommunication, steel, and petroleum. About 5%-7%
For analysis of economic reform and stock market, see Lee (1989, 1990). For studies of SOE reform see Lee
are former town and village enterprises. The issue of property right has not been fully
resolved. These enterprises behave like family business in Hong Kong and Taiwan, except
that many layers of government can have direct control over them. About 5%-7% are joint
venture, arising from the multinational firm from abroad seeking partnership with SOEs. The
government’s meddling hands are in all listed companies. In this paper, we investigate a
specific aspect of government’s visible hand: how the state-ownership of listed companies
affects the government taxation treatment and fiscal transfer.
Stock Market Regulation
As an emerging market in a transition economy, Chinese stock market exhibits two rather
unique characteristics: (1) a wide range of stock transactions involved the approval and
regulation of multi-layers of governments and agencies and (2) a tight quota system designed
to assure a stable development of the market in infancy. Before 1992, listed companies were
located only in Shenzhen and Shanghai. They were chosen as guinea pigs for the new stock
markets. After 1993, with the deepening of economic reform, the two stock markets were
slowly opened up to companies around the country. At the same time the Chinese Securities
Regulation Commission, an executive branch of State Council Securities Commission, was
established to monitor and to regulate the market transactions.
The approval for public offering went through a complicated administrative review
process. First, the local governments or a state administrative bureau recommended SOEs
under their jurisdictions for listing.6 Then the Listing Department of CSRC examined the
Each SOE is supervised by a local government or an administrative bureau in the central government, or both.
For example, the Bao Steel Corp, a major steel company, is supervised by the State Steel Administrative Bureau.
Shanghai First Motors Corp, a major automobile manufacturing firm, is supervised by both the State Economic
application materials and asked for supporting opinions from the State Planning Commission
and State Economic and Trade Commission. After the CSRC collected and reviewed the
supporting documents, the Public Offering and Listing Review Committee of CSRC cast
votes for the final approval. To accommodate the fast changing stock market and to respond
to gaming, the administrative review process has been evolving.
To assure stable and manageable stock market development, the Central Planning
Committee in State Council set annual quota for all financial transactions in the stock market.
The annual quota, once decided by the Central Planning Committee, is allocated among
provinces and state administrative bureaus that have the authority to recommend the list of
public offerings. These administration units decide the quota shares among their
recommended list of SOEs. It is no coincidental that the proportion of various type of
ownership in Table 1 stays quite constant over the whole sample period. This is a result of
IPO quota system. Each administrative unit (hence, the type of ownership) has
pre-determined quota on the number of cases and the dollar volume for each case of IPO.
Each SOE pushed and shoved to get the maximum share of quota within its
administrative unit. The regional governor and state administrative bureau chief elbowed and
jostled to get the maximum quota for their own jurisdictions. Getting the quota is often
viewed as the sign of political clout and superb performance for both regional governors and
SOE managers. The stringent quota created incentive for regional governors and SOEs
managers to collude. Responding to this collusion, central government adjusted regulation to
maintain an orderly progressing stock market. Chinese Tango is about this three-person game
and Trade Commission and Shanghai Government.
of earnings management, fiscal subsidies, and central government regulation.
3. EARNINGS MANAGEMENT BY LISTED FIRMS
After the birth of stock market, SOEs found equity financing much more attractive than
debt financing. The approval for IPO is a highly sought after privilege. In contrast to bank
loan, equity financing does not require the payment of interest and principal. Moreover, the
stringent quota and strong government involvement signaled to the market that the central
government’s blessing and creditability were behind every IPO. This government backing
leads investors to ignore the listed firm’s fundamental. The investors looked for the economic
rent associated with the stringent quota. Getting the approval to go public is equivalent to
gaining the right of nearly zero cost financing. To select firms with good performance for
listing, the central government set the criterion of “at least two consecutive years of operating
profits” as the major condition for IPO. Aharony, Lee and Wong (1999) showed that SOEs
had strong incentives to conduct earnings management to meet this requirement.7
Earnings management by managers is a universal phenomenon.8 The incentive and
the ways to play the game in China are quite different from those documented in other
countries. This study focuses on the incentive to avoid delisting or trading restrictions due to
the listed firm’s poor performance and the incentive to get the approval of rights offering.
Moreover, this study describes earnings management beyond adjusting discretionary accruals.
Listed firms in China would conduct earnings management by real transactions. The
Moreover, the central government set a guideline for IPO valuation for the stock market at its infancy. CSRC
suggested a P/E multiple of 12 to 15 for setting the initial IPO price. For a new born market, no one had much
experience of market price setting. The suggested P/E multiple became the rule of price setting. For getting a good
IPO price, firms had strong incentives to adjust the accounting earnings upward.
The literature in the U.S. and Europe found three basic incentives for managing earnings: (1) capital market
expectation and stock price; (2) accounting based contracts; (3) anti-monopoly and other government regulations.
The means of earnings management include: (1) changes in accounting policies and (2) the timing of accruals.
supervising government agencies assist and often collude with their charges to come up with
desirable accounting numbers.
Incentive to Avoid Trading Restriction
The stringent quota created huge economic rent for listing right, called “shell” value.9
This shell value is primarily attributable to the special access to costless equity financing.
Firms would go a long distance to get listed. Once listed, the firm would find way to expand
equity financing for harvesting the bountiful “costless” money. This created serious “free cash
flow” problem. Many capital projects from the listed SOEs are frivolous and unprofitable. To
protect the investors and to keep an orderly market, CSRC issued the Special Treatment (ST)
Regulations in 1998: any listed firm with two successive years of loss or with asset value per
share less than face value will be specially treated on the stock exchange.
The trading on ST firms is regulated so that their price volatility is within +5% daily.
Moreover, if the firm gets worse, the regulation gets tighter: the listed firm with loss for
successively three years is classified as “particular transfer (PT)” firm. The price increase in a
PT share cannot be more than 5% for any trading day to prevent insider manipulation.
However, the price of a PT share is allowed to fall without limit. The PT share can only be
traded on Fridays. Moreover, the PT share can be removed from listing at the discretion of the
Stock Exchange manager. Delisting makes the listed firms losing the valuable “shell.” ST and
PT treatments reduce the value of the “shell” to listed firms. To avoid delisting, ST, and PT,
many listed firms manage earnings to keep loss off the book.
The listing right is called a “shell.” The value of shell is the value of a listed firm stripped of fundamental value.
Acquiring a shell is the only way to get access to equity financing for many firms without political clout.
Incentive for Rights Offering
Due to restrictive quota, all listed firms were under-capitalized at IPO. Immediately after
IPO, listed firms prepared rights offering to reach a higher level of capitalization. Not
responsible for dividends and principal, the SOE manager views equity financing as
essentially cost free, they want rights offering disregard of financial needs.10 Essentially no
regulation on rights offering was in place before 1993. Rights offerings were often issued for
expropriating and for getting seemingly costless money.11
The CSRC guideline in 1993 required the rights issuing companies to generate two
successive years of profits before applying for right offering. The criteria got tougher in 1994
by requiring rights offering companies to have three successive years of positive earnings and
an average 10-percent return on equity (ROE).12 To dampen the “Rights Offering Craze,” the
ROE requirement was tightened in 1996 to 10-percent ROE in each of the three previous
years. The 1996 guideline significantly reduced the number of eligible companies, but led to
the breakout of rampant earnings management, known as “10-percent” phenomenon.” In early
1999, due to widespread publicity on this glaring 10 percent phenomenon, the CSRC issued a
new guideline to alleviate earnings management. The ROE requirement was reduced from 10
percent to 6 percent for each of the three previous years.
Earnings Management by Real Transactions
Before a better monitoring system and a more sophisticated information infrastructure are established, seasoned
equity offering can damage existing shareholders’ interest. To protect shareholders, CSRC disallowed seasoned
equity offering until 2001.
Lee and Xiao (2003) documented that soon after rights offering, many listed firms applied the cash receipts to
pay cash dividends to their corporate parents. As Table 1 shows, many of these “parents” are local governments.
The ROE requirement for certain national industries such as agriculture, energy, raw material, infrastructure and
high-technology was 9-percent.
The ways and means of earnings management in China are quite different from those in
other nations. With a well-developed legal and accounting infrastructure, earnings
management in the U.S. is primarily carried out through the discretion choices of accrual
accounting. With a primitive legal system and rigid rule-based accounting standards, earnings
management in China is mostly done through real transactions. As pointed out by Lee (1996,
2001), part of SOE functions under planned economy were social services like education and
hospital. These non-business activities are not suitable for public listing in stock market.
Hence, most listed companies were a carve-out from their parent SOEs. In practice, the listed
company and its parent SOE are often “two name plates on the same office”; they share the
same staff and executives.13 The parent SOE has full right to appoint the board member and
top management of listed company. The manager of listed company often faithfully represents
the interest of parent SOE in dealing with other stakeholders. Therefore earnings management
induced by the principal-agent problem between manager and shareholders is not important in
China. As the controlling shareholder, the parent-SOE has the incentive to assist the manager
of listed company adjusting earnings to meet the contractual requirement with other parties.
Because of direct control, the transaction cost of using real transaction between listed
companies and their parent firms as means of earnings management is much lower in China
than in elsewhere.
The State Administration of Taxation in Beijing sets tax rate and the policy of
preferential treatments. The local government is responsible for implementation. Lack of
The top executives of listed firms often come from the local government and will go back as bureaucrats when
the tenure is over. The chairman of board of listed company is a coveted position for retired government
bureaucrats. Hence, the local government and listed SOE on the one hand and the government bureaucrats and
company executives on the other are all closely related in symbiotic ways.
sophisticated monitoring and control, the local government has quite room for discretionary
decisions to meet its fiscal responsibility. As shown in Table 1, the local government is the
ultimate shareholder of about 85% of listed firms. The relationship between the listed firm
and the local government is more than that between the taxpayer and the public service
provider. If the controlling SOE and its listed carve-out hold a parent-son relationship, the
local government is essentially the grandpa to the listed firm. This cozy family tie gives rise
to another way of earnings management by real transaction unique in China. The local
government may use taxation and fiscal subsidies to assist the listed firm to manage earnings
for meeting the central government regulation.
4. TAXATION AND FISCAL TRANSFERS
Taxation Preferences and Effective Tax Rates
The standard Enterprise Income Tax rate in China is 33% for all domestic enterprises.14
The tax code allows tax exemption or reduction for enterprises in certain industries, such as
high-tech and agriculture, and in certain regions, such as special economic zones and western
underdeveloped regions. To attract foreign investment, the tax code also provides favorable
treatments to joint venture. Typically the State Administration of Taxation sets the guideline
for preferred tax rate as 15%. Local government decides which enterprise meets the
requirement for preferred tax status and grants the tax preferences.
Insert Table 2
Table 2 summarizes the distribution of effective income tax rates paid by listed
The term “enterprise” indicates all business entities. Although China has had Corporate Law since 1986, the
transformation of socialist business organization to the modern corporation is still in progress. The Enterprises
Income Tax Code applies to all forms of business.
companies based on the footnote disclosure in the annual reports.15 The local government
collects all income taxes and submits part of collection to Beijing. The sharing ratio varied
from year to year. Starting from 2002, the sharing ratio is 50-50. Table 2 shows an interesting
pattern; about 85% of listed firms paid the preferred 15% effective tax rate. Since the local
government and listed firms have close relationship, we detect a rather clear moral hazard
issue for the local government to serve as the tax collection agent for Beijing. The local
government can directly benefit from the tax preference to the listed firm, but the central
government pays half of the cost. It should not be surprising to see local government’s
taxation generosity to listed companies in its jurisdiction. Moreover, the tax competition
among regional government to attract business activities adds power to this incentive. The
central government noticed this issue and tightened the tax preference regulation in 2000, the
number of listed companies paying 33% rate increased slightly as a result.
Fiscal transfers from local government to listed firm include fiscal subsidies and tax
rebates. The Ministry of Finance regulates the fiscal subsidies. The primary policy goal of
fiscal subsidies is to develop the strategic areas such as agriculture, public utility, and
high-tech. The local governments have the authority to determine the amount and timing of
fiscal subsidies as part of their own budgeting. The fiscal transfers received by listed
companies are reported as a separate item in the income statement, with the sources disclosed
in the footnotes. Since this disclosure is not uniformly detailed across companies, we find it
difficult to provide comprehensive summary statistics. Our careful analysis of data shows five
Firms listed before 1993 got special policy treatments as guinea pigs. Our sample excludes these firms. See
Chen, Kwan and Xiao (2001) for details.
major types of fiscal transfers: (1) income tax rebates, (2) value-added tax (VAT) rebates,16 (3)
compensatory subsidies for social infrastructure, 17 (4) project subsidies for technology,
innovation, environment, etc, and (5) direct financial assistances.
As far as earnings management is concerned, there are four major differences between
tax preference and fiscal transfers. First, local government’s authority on tax preference is to
determine the firm’s attributes. Once classified, it is hard to change. Earnings management is
event-based. It is difficult to use a permanent instrument for one-time event-based purpose.
Fiscal transfer, that can vary from time to time, is more suitable for earnings management.
Second, the local government has much more discretion on fiscal transfers than on tax
preferences. Hence, the local government finds it easier to use fiscal transfer as an instrument
for assisting listed firms on earnings management. Third, fiscal transfers are out of local
government’s own pocket. Hence, local government would use this instrument a lot more
prudently. Tax preference is offered to listed firms quite generously. Fourth, fiscal transfers
can be applied more precisely and promptly than tax preference for the purpose of earnings
Insert Table 3
Table 3 reports the descriptive statistics of the fiscal transfers from 1994 to 2000. No
company received fiscal transfers in 1993. Panel A of Table 3 shows that the mean of fiscal
transfers and the ratio of fiscal transfers to reported income increased year after year. In 1994
VAT rebates are offered to product exports and raw materials imports to stimulate industry upgrade. Local
government’s share of VAT is 25% and central government’s share is 75%. Local government has complete
discretion to use VAT rebates to assist listed companies.
For example, Beijing Municipal Government gave Beijing Capital Co. RMB 360 million each year from 1998
to 2000 to compensate for loss related to highway construction.
only about 5% of the companies obtain fiscal transfers, and from 1995 to 1997 the percentage
increased to about 20%. The percentage jumped to almost 50% after 1998. The mean value of
fiscal transfers went up five times from RMB 1.13 million in 1997 to RMB 5.57 million in
1999. The mean ratio of fiscal transfers to reported income tripled from 3.37% in 1997 to
11.39% in 2000. Panel B of Table 3 shows the number and the percentage of firms receiving
fiscal transfers each year. The percentage of firms receiving fiscal transfers increased more
than ten times from 4.75% in 1994 to 55.38% in 1999. Fiscal transfer is an increasingly
important contributor to the net income of listed firms.
A Preliminary Look: Preferred taxation, fiscal transfers and the ROE
We conduct a preliminary exploration in Tables 4 and 5 on the relationship between the
ROE requirement and local government behavior. Table 4 shows the relationship between tax
preference and various ROE requirements. Panel A shows that no significant difference in the
frequency of tax preference on marginally profitable firms from other firms. Panel B shows
no significant difference in the frequency of tax preference on marginally rights offering
qualified firms from other firms. Panel C shows no association between tax preference and
clearly qualified rights offering firms. Table 4 indicates that the tax preference seems not
related to CSRC ROE requirements. Almost all companies received tax preferences.
Insert Table 4 and 5
Table 5 presents the distribution of ROE before and after fiscal transfers. It appears that
fiscal transfers turned all but two incipient loss firms into more than breakeven over the seven
years in our sample. Similarly, fiscal transfer turned large number of incipient rights offering
firms into rights offering qualified. The last column of Table 5 indicates that few firms
moving into clearly rights offering qualification through fiscal transfers alone. Hence, fiscal
transfers were applied with discretion. Only after a listed firm made effort to get close would
the local government provide fiscal transfers to get it over the hurdle. In addition, the cost for
local government to provide fiscal transfer to listed SOEs is very small compared with the
large pool of local government fiscal revenue.18 Combining the results from Tables 4 and 5,
the dancing floor for Chinese Tango seems located in fiscal transfers. Tax preferences do not
factor much in meeting the ROE requirement.
5. CHINESE TANGO: COLLUSION OF GOVERNMENT AND LISTED FIRM
The Chinese Tango moves with the tune of CSRC ROE requirements. We suggest four
possible sets of choreography of Chinese Tango according to various CSRC requirements.
Tables 4 and 5 have provided preliminary hint, we now formally develop the hypotheses.19
Essentially all listed firms seek after rights offering. CSRC has stipulated varying ROE
requirements to regulate the market. The listed firm with ROE before fiscal transfers (hereon,
ROEBF) close to meet the ROE requirement should have high probability to receive fiscal
transfers. If fiscal transfers are primarily for earnings management, we should observe that
those listed firms already qualified for rights offering without government assistance should
be less likely to receive fiscal transfers. Hence, we propose following hypotheses.
See appendix 1 for statistics on the average percentage of fiscal transfer to listed companies to the total local
government fiscal revenue. The average percentage is about 1%.
The CSRC (2001) refined the ROE benchmark, requiring that the target ROE is the ROE based on net profit or
the ROE excluding non-operating profits, whichever is lower. But our sample periods from 1994 to 2000 are not
affected by this new regulation, and the fiscal transfer could be used as an effective means to help earnings
H1a. The listed firm with ROEBF close to meeting rights offering requirement has
higher probability of receiving government fiscal transfers.
H1b. The listed firm already qualified for rights offering without government assistance
is less likely to receive government fiscal transfers.
Under tight central government control, the “listing” itself is a very valuable economic
resource for both the listed firm and its locale. After CSRC issued the regulation on “ST” and
“PT” in March 1998 based on the ROE requirement, the listed firm and the local government
may dance with this tune. The listed firm close to dip into loss should have a higher
probability of getting fiscal transfers. The listed firm in deep loss should have less chance of
getting fiscal transfers. Hence, we have following hypotheses.
H2a. The incipient loss firm has higher possibility to receive government fiscal
H2b. The listed firm suffering large losses is less likely to receive fiscal transfers from
Naturally, the firm with profit would try to reach the rights offering threshold as suggested in
Hypotheses 1a and 1b.
Table 3 shows an increasing trend in the fiscal transfers. This phenomenon may arise
from the evolvement of CSRC’s regulation on rights offering and delisting. In responding to
Chinese Tango, CSRC changes her music by making the regulation tighter. As the music
switches, the choreography of Chinese Tango changes accordingly. Hypothesis 3 illustrates
the dynamic three-person game: the local government colludes with listed firms to circumvent
CSRC regulation, CSRC changes regulation to frustrate the circumvention, the local
government and the listed firm create new Tango steps to outwit, and on and on. Based on
regulation changes, we divide our sample into three regime periods: from 1994 to 1995,
during which regulation on the rights offering only requires successive positive ROE with no
requirement on delisting; from 1996 to 1997, when the rights offering regulation became
tough with minimum 10% ROE requirement, but there was still no regulation on delisting;
and from 1998 to 2000, when the regulation on rights offering changed again and a new
regulation of “ST” and “PT” was stipulated.
H3. The relation between fiscal transfers and ROE changes with the CSRC’s ROE
The incidence of Chinese Tango depends on the closeness of the relation between the
listed firms and the local government. Those controlled or owned by the local government
should have the closest relation. Those town and village enterprises and joint venture should
have symbiotic relation. Those controlled or owned by the central government should have
the least relation. These three types of ownership should affect the attributes of fiscal
H4. The association between fiscal transfers and CSRC ROE requirement is strongest in
local listed firms, weakest in firms controlled or owned by central government, and modest in
town and village enterprises and joint venture firms.
6. EMPIRICAL RESULTS
Specification and Measurement
We use a logistic regression to estimate the probability of receiving fiscal transfers from
Pr ob( FT = 1) =
1 + e −z
where FT is a binary variable, with FT=1 for receiving fiscal transfer and FT=0 otherwise; Z
represents a linear combination of the variables that may affect the probability of receiving
fiscal transfers. The definitions and measurement of explanatory variables are provided in
Table 6. According to Hypotheses 1 and 2, INCIPIENT_RIGHT and INCIPIENT_LOSS are
expected to be positively associated with the probability of receiving fiscal transfers.
CLEAR_RIGHT and CLEAR_LOSS should be negatively associated with the probability of
fiscal transfers. The two time dummy variables, PERIOD2 and PERIOD3, intend to capture
part of the policy regime effect articulated in Hypothesis 4.
Insert Table 6
The second half of Table 6 lists possible explanations on fiscal transfers beyond Chinese
Tango. They serve as control variables in our test of Hypotheses 1 to 4 based on the Theory of
Chinese Tango. The variable DEBT/ASSET indicates the debt burden of listed firm. Local
government may provide fiscal transfers to the financially distressed listed firm as a part of
community bear-out effort. As mentioned in Section 4, the policy of fiscal transfers was set in
Beijing with promoting strategic industry as a goal. Hence, we use the dummy variable
INDUSTRY to capture the industry effect. The value of INDUSTRY is one for high-tech,
public utility, or agricultural industries and zero otherwise. TOTAL_ASSET is to capture the
usual size effect. The variable LOCAL_GDP controls for the wealth effect of the region. The
richer region can afford more fiscal transfers. The variable FISCAL_REV (per capita fiscal
revenue in the region) controls for the budget tightness of the local government. The richer
local government can afford being more generous.
Insert Table 7
Table 7 presents the summary statistics of variables in Table 6 for the period of
1994-2000. We compare the sample attributes of the listed firms receiving fiscal transfers vs.
those without fiscal transfers. T-test is applied to continuous variables and chi-square test is
applied to binary variables. Panel A shows that firms with fiscal transfers are larger, deeper
into debt, in richer region and under a richer regional government than firms without fiscal
transfers. Hence, budget constraint and economic environment affect fiscal transfers in
predictable ways. Panel B shows that (1) firms close to meet the CSRC ROE threshold for
rights offering have higher frequency of receiving fiscal transfers than other firms; (2) firms
clearly meeting the ROE threshold for rights offering have lower frequency of receiving fiscal
transfers; and (3) firms close to dipping into loss have higher frequency of receiving fiscal
transfers. These findings are consistent with Hypotheses 1 and 2. Next, we turn to more
comprehensive and rigorous test on the Theory of Chinese Tango.
Table 8 provides an overall perspective on the test of Chinese Tango Theory for the
whole sample period of 1994-2000. The results in Table 8 are consistent with that in Table 7,
but stronger. We can infer six implications from Table 8 on local government’s decision on
fiscal transfers. First, the listed firms close to meeting the rights offering requirement has
higher probability of receiving fiscal transfer, consistent with Hypothesis 1a. Second, the
listed firms clearly qualified for rights offering requirement have lower probability, consistent
with Hypothesis 1b. Third, the listed firms close to dipping into loss have higher probability,
consistent with Hypothesis 2a. Fourth, the listed firms clearly in loss have lower probability,
consistent with Hypothesis 2b. Fifth, the listed firm in financial distress has higher probability.
Sixth, the fiscal transfers do not favor the strategic industries; the local government does not
exactly follow the central government’s policy on fiscal transfers. Sixth, the richer region and
the wealthier local government tend to offer fiscal transfer more frequently.
Insert Tables 8
We further check the robustness of Hypothesis 1 and 2 by closely examining the
likelihood of receiving fiscal transfer on sub groups. Appendix 2 reports the robustness results
for different pairs of sub groups. Appendix 3 controls for the timing problem of fiscal transfer
decision. Our previous results still hold after excluding the mid-term fiscal decision.
To test Hypothesis 3 on the three-person dynamic game in Chinese Tango, we group the
data into three periods: 1994-1995 for the no-regulation regime, 1996-1997 for the initial
regulation regime, and 1998-2000 for the revised regulation regime. In the initial regulation
regime, CSRC sets the regulation without full knowledge on how other two payers would
react. In the revised regulation regime, CSRC adjusted the ROE requirement in responding to
rampant earnings management activities and irregular trading activities in stock market. The
results are reported in Table 9. The percentage of companies receiving fiscal transfers has
increased: 20.22% in the first period, 20.85% in the second period and 50.83% in the third
period. Regression (1) is a pooled regression like Table 8, with two dummy variables
PERIOD2 and PERIOD3 to measure the dynamic gaming. The result of regression (1) shows
that the probability of receiving fiscal transfer in the revised regulation regime (Periods 2 and
3) is larger than that in the no-regulation regime (Period 1).
Insert Table 9
By studying each regime separately, regressions (2) to (4) provide clearer and more
comprehensive picture than regression (1) on the dynamic gaming. In regression (2) for the
no-regulation regime, INCIPIENT_RIGHT, CLEAR_RIGHT, INCIPIENT_LOSS, and
CLEAR_LOSS are all insignificant. Three variables, DEBT/ASSET, INDUSTRY, and
FISCAL_REV, are significant. These results suggest that under the regime of no-ROE-based
regulation, local government’s fiscal transfer decision ignores ROE. Local government
provides fiscal transfers for three reasons: (1) the listed firm is in financial distress, (2) local
government follows the central government’s policy to promote strategic industry, and (3) the
local government has rich coffer. In the regime of initial ROE-based regulation for rights
offering, regression (3) shows supporting evidence for Hypotheses 1a and 1b. The fiscal
transfers are not related to the strategic industry policy set by the central government. In the
revised regulation regime where additional ROE requirements were set for ST and PT, fiscal
transfers are significantly associated with various ROE requirements. The central
government’s strategic industry policy was ignored by the local government. The results in
Table 9 provide supporting evidence to Hypothesis 3: fiscal transfers change along with the
revisions of the ROE-based regulation.
Insert Table 10
Grouping the data by ownership, we detect clear trace of collusion between local
government and listed firm in Table 10. Regression (1) of Table 10 shows that when the local
government is the largest shareholder, the fiscal transfers are significantly associated with the
ROE requirement, but not with the strategic industry policy. Regression (2) shows that when
the central government is the largest shareholder, the fiscal transfers have no significant
association with the ROE requirement, but are significantly associated with the strategic
industry policy. Regression (3) finds a moderately significant evidence for the local
government to assist the town and village firm managing earnings to cross over the threshold
of rights offering ROE requirement. Regression (4) shows that the local government offers
fiscal transfers to joint venture firms clearly meeting the rights offering ROE requirement.
These fiscal transfers are more likely served as an inducement to attract high-performing joint
venture firms than as an instrument for earnings management.
China is an underdeveloped economy going through economic transition. The stock
market is developed to facilitate economic restructuring as well as to promote economic
development. During the long painful process of economic restructuring, the local
government serves four roles to the listed firm: a provider of public service, an agent for
central government to monitor the listed firm, a major shareholder, and a symbiotic partner.
This complicated relationship gives rise to Chinese Tango: the local government intimately
dances with the listed firm with the tune set by the central government.
The tight quota system left almost all listed firms undercapitalized and hunger for the
privilege of rights offering. The ruthless competition among listed firms forced CSRC to use
the ROE requirement to raise the threshold for rights offering. With rigid rule-based
accounting, the listed firms have limited instruments for earnings management. As a result,
the local government lent a helping hand by providing fiscal transfers to boost the listed
firm’s ROE. Our empirical study suggests that the local governments freely used the taxation
preference to compete for attracting economic activities into their regions. The fiscal transfers
were used to help listed firms on which the local government held majority ownership to
manage earnings to circumvent CSRC’s ROE requirement. We find evidence of moral hazard
in the local government’s role as an agent for the central government.
A popular saying in China fairly summarizes the lesson of economic reform over the
past two decades: “There is a circumventing strategy from below to whatever regulation set at
above.” Throughout the rapid course of economic reform, multi-layers of principals and
agents tried very hard to learn their roles in the market. They constantly found ways to take
advantage of the circumstances as a necessity for survival and adjusted the rule of the game
along the way to assure future advantage. Through these actions and reactions, the players
develop the market as an institution. Studying the case of China economic reform provides us
interesting insight on the development of the invisible hand.
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Who Own the Listed Companies in China?
Local Central Town and Foreign Joint Sample
Government a Government Village b Venture
1993 c 218 3 16 15 252
(86.51%) d (1.19%) (6.35%) (5.95%)
1994 250 4 20 20 294
(85.03%) (1.36%) (6.80%) (6.80%)
1995 288 5 24 16 333
(86.49%) (1.50%) (7.21%) (4.80%)
1996 496 9 38 29 572
(86.71%) (1.57%) (6.64%) (5.07%)
1997 636 23 46 41 746
(85.25%) (3.08%) (6.17%) (5.50%)
1998 725 27 47 47 846
(85.70%) (3.19%) (5.56%) (5.56%)
1999 809 29 53 48 939
(86.16%) (3.09%) (5.64%) (5.11%)
2000 952 33 48 62 1095
(86.94%) (3.01%) (4.38%) (5.66%)
The local government includes provincial government and metropolitan city government.
Town and village enterprises are hybrid between SOE and private business. The issue of property
right has not been fully resolved. These firms behave like family business in Hong Kong and Taiwan,
except that the local government has strong direct control over them.
Chinese security market began at 1990 with a couple of listed companies on experimental basis. The
formal IPO started in 1993.
The number in bracket indicates the proportion of total sample.
Effective Income Tax Rates Paid by Listed Companies
China adopts a uniform enterprise income tax policy. The statutory Enterprise Income Tax
rate is 33%; the local government has discretion to adjust the effective income tax rate. We
derive the effective income tax rates from annual reports filed at CSRC.
Effective Income Tax Rates a
33% 15% b 0% c others d Sample
5 229 2 16 252
(1.98%) (90.87%) (0.79%) (6.35%)
1994 8 260 3 23 294
(2.72%) (88.44%) (1.02%) 7.82%
16 290 4 23 333
(4.80%) (87.09%) (1.20%) (6.91%)
1996 30 489 13 40 572
(5.24%) (85.49%) (2.27%) (6.99%)
1997 36 633 27 50 746
(4.83%) (84.85%) (3.62%) (6.70%)
1998 37 726 31 52 846
(4.37%) (85.82%) (3.66%) (6.15%)
1999 55 789 28 67 939
(5.86%) (84.03%) (2.98%) (7.14%)
2000 151 854 24 66 1095
(13.79%) (77.99%) (2.19%) (6.03%)
Each entry is the number and the percentage of companies for given level of effective income tax rate.
This group includes companies that receive the tax preference treatment at rate of 15% (the
preference treatment may be legitimate or not) and companies that pay the income tax at 33% rate first
and then receive local governments tax rebate to arrive at the effective income tax rates are 15%.
Companies with zero income tax or with fully refunded income tax.
Companies with other levels of effective income tax rates.
Fiscal Transfers to Listed Companies
Panel A Amount of Fiscal Transfer a Unit: Million RMB
1994 1995 1996 1997 1998 1999 2000 1994-2000
Maximum 20.89 31.76% 119.16 1129% 63.92 152% 96.75 633% 142.73 1191% 360.00 824% 360.00 2570% 360.00 2570%
Minimum 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Median 0 0 0 0 0 0 0 0 0 0 13 0.27% 0 0 0 0
Mean 0.20 0.35% 1.46 6.39% 0.88 2.04% 1.13 3.37% 4.98 10.49% 5.57 10.72% 3.65 11.39% 2.79 7.19%
Std. Dev 1.54 2.52% 9.26 63.41% 5.11 15.26% 6.08 31.91% 14.23 52.85% 17.40 49.39% 14.97 94.76% 12.19 57.62%
Panel B Number of Listed Firms Receiving Fiscal Transfers
1994 1995 1996 1997 1998 1999 2000 1994-2000
Companies with 14 74 122 151 420 516 526 1828
Subsidy c (4.75%) (22.16%) (21.29%) (20.19%) (49.41%) (54.66%) (47.82%) (35.98%)
The percentage on the right is fiscal transfer per dollar of before tax income.
In 1993 no company receives fiscal transfer from government. Analysis from hereon will ignore 1993.
c The figure in bracket indicate percentage of sample in given year.
TABLE 4 Taxation Preferences and CSRC Required ROE a
For each year, the observed and expected proportions of companies with tax preference are given in each group
classified by ROE. This table examines the possible association between CSRC required ROE and tax preferences.
The expectation is based on the null hypothesis of no association.
Panel A Tax Preference and Marginal Profitability
1994 b 1995 b 1996 1997 1998 1999 2000
Profitable 50% 90.32% 96.36% 86.96% 95.08% 90.14% 83.53%
Others 96.61% 95.71% 94.59% 96.57% 95.80% 94.48% 86.28%
Expected 97.29% 95.21% 94.76% 95.98% 95.74% 94.16% 86.07%
Chi-square Test 34.37*** c 1.768 0.314 10.338*** 0.071 2.249 0.494
Panel B Tax Preference and Marginal Rights Offering Qualification
1994 1995 1996 1997 1998 1999 2000
Qualified 50% 90.32% 93.88% 97.46% 97.53% 95.07% 88.52%
Others 96.61% 95.71% 95.07% 95.11% 94.85% 93.99% 85.36%
Expected 97.29% 95.21% 94.76% 95.98% 95.74% 94.16% 86.07%
Chi-square Test 34.37*** c 1.768 0.313 2.504 3.314* 0.255 1.582
Panel C Tax Preference and Clear Right Offering Qualification
1994 1995 1996 1997 1998 1999 2000
Qualified 97.85% 95.35% 94.59% 94.42% 94.81% 95.17% 85.37%
Others 87.50% 94.74% 94.85% 96.54% 95.95% 93.28% 86.42%
Expected 97.29% 95.21% 94.76% 95.98% 95.74% 94.16% 86.07%
Chi-square Test 6.14** 0.048 0.016 1.693 0.408 1.521 0.227
The ROE range for each year is defined according to the CSRC regulation on rights offering and listing qualification. The 1994
regulation requires at least three successive years of positive ROE in order to get the approval of right offering. The 1996
regulation set a minimum ROE requirement of 10% for each of the three year. In early 1999, new guideline reduced the ROE
requirement to 6%. For retaining listing qualification, no regulation is set until the issue of ST and PT regulation in 1998 that
made negative ROE as exit condition. The Marginally Profitable Firms have ROE in the range of (0, 2%) for 1994-2000 each
year. The Marginally Rights Offering Qualified Firms have ROE in the range of (0, 2%) for 1994-1995, (10%, 12%) for
1996-1998, and (6%-8%) for 1999-2000. Clearly Rights Offering Qualified indicates the companies’ ROE larger than the
minimum requirement of right offering, defined as (4%, ∞) for 1994-1995, (14%, ∞) for 1996-1998, and (10%, ∞) for
In 1994 and 1995, the marginally profitable firms are exactly the same as the marginally rights offering qualified firms.
In 1994, the number of companies in marginally profitable and marginally rights offering qualified range is only 4. The
Chi-square test may not be meaningful for 1994.
Fiscal Transfers and CSRC Required ROE
Each entry Indicates the number of companies with ROE in given range. CSRC uses ROE as
criteria for delisting and right offering. This table shows the possible association between local
government fiscal transfers and CSRC ROE threshold.
ROE Range a
Incipient Right Offering Clearly Rights
Incipient Loss b
Qualified c Offering Qualified d
Before After Before After Before After
Transfer Transfer Transfer Transfer Transfer Transfer
1994 0 0 0 0 14 14
1995 5 1 5 1 67 72
1996 6 0 10 4 59 72
1997 3 0 19 4 77 106
1998 10 0 85 27 174 275
1999 11 0 48 15 323 403
2000 10 1 70 31 323 378
The ROE range for each year is defined according to the CSRC regulation on rights offering and listing
qualification. The 1994 regulation requires at least three successive years of positive ROE in order to get the
approval of right offering. The 1996 regulation set a minimum ROE requirement of 10% for each of the three
year. In early 1999, new guideline reduced the ROE requirement to 6%. For retaining listing qualification, no
regulation is set until the issue of ST and PT regulation in 1998 that made negative ROE as exit condition.
The Incipient Loss Firms have ROE in the range of (-1%, 0) for 1994-2000 each year
The Incipient Right Offering Firms have ROE in the range of (-1%, 0) for 1994-1995, (9%, 10%) for
1996-1998, and (5%,6%) for 1999-2000.
Clearly Rights Offering Qualified indicates the companies’ ROE larger than the minimum requirement of
right offering, defined as (1, ∞) for 1994-1995, (11%, ∞) for 1996-1998, and (7%, ∞) for 1999-2000.
Variables Definition and Measurement
Proxy Variable Measurement
DFT Dummy variable, 1 if FTa>0; 0 otherwise;
INCIPIENT_RIGHT 1 for ROEBFb ranging from –1% to 0 for 1994 and 1995 from 9% to
10% for 1996 to 1998, and from 5% to 6% for 1999 and 2000, and 0
CLEAR_RIGHT 1 for ROEBF greater than 0% before 1996, greater than 11% from
1996 to 1998, and greater than 7% for 1999 and 2000, and 0 otherwise;
INCIPIENT_LOSS 1 for ROEBF within the range of –1%~0, and 0 otherwise
CLEAR_LOSS 1 for ROEBF less than –1%, and 0 otherwise
PERIOD2 1 for sample in year 1996 and 1997, and 0 otherwise;
PERIOD3 1 for sample in year 1998, 1999 and 2000, and 0 otherwise;
DEBT/ASSET Debt to asset ratio;
INDUSTRY 1 for firms in high-tech, public utility or agricultural industry, and 0
TOTAL_ASSET Natural logarithm of the total asset；
LOCAL_GDP Natural logarithm of per capita GDP in the firm’s local region;
FISCAL_REV Natural logarithm of per capita fiscal revenue in the company’s locale；
a FT is the Fiscal transfer received by firm reported in the annual report;
ROEBF indicates returns on equity before fiscal transfers.
Descriptive Statistics (1994-2000)
Panel A Continuous variables
Firms with Fiscal Firms without Fiscal
Variable a Mean S.D Mean S.D T statistics b
DEBT/ASSET 0.442 0.168 0.414 0.159 5.51***
LNASSET 11.510 0.845 11.315 0.750 7.95***
LGDP 9.184 0.649 8.943 0.571 12.89***
LFNC 6.520 0.772 6.171 0.869 12.85***
Panel B Discretionary variables
Frequency of receiving fiscal transfer
Variable Variable value =1 Variable value=0 Chi-Square C
INCIPIENT_LOSS 86.67% 36.82% 15.94***
CLEAR_LOSS 36.79% 39.93% 1.081
INCIPIENT_RIGHT 71.15% 35.30% 109.32***
CLEAR_RIGHT 31.22% 44.26% 79.88***
IND 38.16% 36.72% 0.591
EXPORT 43.43% 36.31% 8.371***
For variable definition, see Table 6.
T-statistics is to test the significance of the mean difference of continuous variables between the subsidy
group and non-subsidy group
Chi-Square statistics is to test the differences between the observed frequencies and the expected
frequencies of the binary variables.
*, **, ***Significant at a level of 0.1, 0.05 and 0.01 using one tailed test. Bold-type highlights significant
Local Government Fiscal Transfers Decision (1994-2000)
An Overall Perspective
Variable a Sign (1) (2)
Coefficient P value Coefficient P value
INTERCEPT -0.420 (<.0001) -6.292 (<.0001)
0.683 (<.0001) 0.790 (<.0001)
- -0.656 (<.0001) -0.571 (<.0001)
+ 1.578 (<.0001) 1.587 (<.0001)
- -0.392 (0.0067) -0.380 (0.0101)
+ 0.705 (<.0001) 0.604 (<.0001)
Observations 4825 4825
-2 Log L 6135.99 5891.45
The dependent variable is a binary choice variable DFT which is one for firms with fiscal transfers
and zero otherwise. For definition of explanatory variables, see Table 6. Bold-type highlights
significant findings. The estimates are based on Logistic Regression.
Rights Offering Regulation and Fiscal Transfer Decision:
A Dynamic Three-Person Game
Period 1 Period 2 Period 3
Whole Sample 1994-1995 1996-1997 1998-2000
No Regulation Initial Regulation Revised Regulation
Observations 4825 627 1318 2880
Percentage of Fiscal Transfer 37.82% 13.99% 20.85% 50.83%
Pooled b Period 1 c Period 2 Period 3
(1) (2) (3) (4)
INTERCEPT a -7.545 (<.0001) -34.576 (<.0001) -14.914 (<.0001) -3.358 (0.0013)
INCIPIENT_RIGHT 0.672 (<.0001) -0.010 (0.9953) 0.676 (0.0240) 0.738 (<0.0001)
CLEAR_RIGHT -0.509 (<.0001) -0.193 (0.8624) -0.804 (<.0001) -0.390 (<0.0001)
INCIPIENT_LOSS 1.638 (<.0001) 1.714 (0.2665) 14.690 (0.9732) 1.397 (0.0021)
CLEAR_LOSS -0.551 (0.0003) -0.395 (0.2782) -0.502 (0.0030)
DEBT/ASSET 0.702 (<0.0001) 1.187 (0.0210) 1.644 (0.0003) 0.592 (0.0013)
INDUSTRY 0.051 (0.5432) -0.728 (0.0765) 0.103 (0.6026) 0.126 (0.1930)
TOTAL_ASSET 0.018 (0.0132) 0.090 (0.5173) 0.004 (0.8266) 0.024 (0.0048)
LOCAL_GDP 0.632 (0.0005) 4.115 (0.0003) 1.674 (0.0001) 0.376 (0.0774)
FISCAL_REV 0.011 (0.9223) 0.979 (0.1741) 0.297 (0.3170) -0.072 (0.6497)
PERIOD2 0.220 (0.1334)
PERIOD3 1.530 (<.0001)
The dependent variable is a binary choice variable DFT. For definition of explanatory variables, see Table 6.
Entries show the estimated coefficient with p-value in bracket. In Period 1, no company has clear loss. Bold-type highlights significant findings.
Period 1 indicates the regime of no regulation, Period 2 indicates the regime of initial regulation, and Period 3 indicates the regime where regulation
is revised to cope with the game playing in the stock market.
Firm Ownership and Fiscal Transfers Decision:
Government-Firm Relation and Fiscal Transfers
Local Firms Central Firms Town and Village Joint Venture
Observations 4156 130 271 268
Percentage of fiscal transfer 37.95% 48.46% 31.73% 36.80%
Local Firms b Central Firms Town and Village Joint Venture
(1) (2) (3) (4)
INTERCEPT a -7.744 (<.0001) 9.350 (0.1709) -13.542 (0.0021) 14.672 (0.0063)
INCIPIENT_RIGHT 0.577 (<.0001) 0.803 (0.4073) 2.602 (0.0046) 0.841 (0.2108)
CLEAR_RIGHT -0.644 (<.0001) -0.703 (0.2482) 0.553 (0.2324) 0.863 (0.0199)
INCIPIENT_LOSS 1.676 (<.0001) 13.521 (0.9872) 1.323 (0.3746) 1.067 (0.4025)
CLEAR_LOSS -0.541 (0.0011) 13.549 (0.9837) -0.736 (0.3741) -0.567 (0.3755)
DEBT/ASSET 0.708 (<.0001) 5.000 (0.0007) 0.462 (0.5230) 0.158 (0.7653)
INDUSTRY -0.024 (0.7919) 1.418 (0.0055) 1.222 (0.0052) 0.298 (0.4082)
TOTAL_ASSET 0.015 (0.0675) 0.015 (0.7590) 0.065 (0.0839) 0.058 (0.0947)
LOCAL_GDP 0.734 (0.0002) -2.996 (0.0229) 0.773 (0.3689) 1.185 (0.2390)
FISCAL_REV -0.092 (0.5115) 2.249 (0.0085) 0.298 (0.6531) 0.083 (0.9015)
PERIOD2 0.212 (0.1755) 0.208 (0.8325) 1.262 (0.1473) -0.251 (0.7001)
PERIOD3 1.507 (<.0001) 1.209 (0.1964) 2.741 (0.0009) 1.106 (0.0534)
The dependent variable is a binary choice variable DFT. For definition of explanatory variables, see Table 6. The estimates are based on Logistic
Entries show the estimated coefficient with p-value in bracket. Bold-type highlights significant findings.
Average percentage of total Fiscal transfer to local government fiscal
revenue by region and year
Region FT/LOCAL_REVa YEAR FT/LOCAL_REV b
1 0.31% 1994 0.01%
2 0.20% 1995 0.10%
3 0.09% 1996 0.09%
4 0.11% 1997 0.15%
5 0.41% 1998 1.10%
6 0.39% 2000 0.63%
Average ratio by region for the total fiscal transfers provided to the local listed
firms each year divided by the total local government fiscal revenue in that year
Average yearly ratio of total fiscal transfers to listed firms on the total local
government fiscal revenues
Appendix 2 Close look of Fiscal Transfer Decision: Regression on FT-groups
Pr ob( DFT = 1) =
1 + e−z
Group classification based on ROEBF
R1 R2 R3 R4 R5 R6 R7
(-∝,-1%) (-1%, 0) (0, 1%) (1%, R -1%) (R-1%, R) (R, R+1%) (R+1%, ∝)
*R represents the ROE requirement for right offering, which will vary according to CSRC regulation
R2 is the incipient loss or small negative ROE group, R1 is the clear loss group; R5 is the incipient
right group, and R7 is the clear right group. R3 is the group whose ROEBF is slightly higher than
0%, and R6 has ROEBF slightly higher than the right offering requirement.
Pair 1: Logistic Regression for firms in group R2 and R3 a
Dummy variable D-roe=1 if ROEBS €R2; 0 otherwise
INTERCEPT D-roe IND EXPORT DEBT LNASSET LGDP LFNC
4.445 2.442 0.914 0.051 2.383 -0.150 -2.125 2.316
(0.378) (0.003) (0.052) (0.918) (0.029) (0.486) (0.034) (0.003)
Pair 2: Logistic Regression for firms in group R5 and R6 b
Dummy variable D-roe=1 if ROEBS €R5; 0 otherwise
INTERCEPT D-roe IND EXPORT DEBT LNASSET LGDP LFNC
-7.054 1.745 -0.073 0.311 0.402 0.076 0.477 0.147
(0.003) (0.000) (0.715) (0.227) (0.432) (0.459) (0.266) (0.635)
Pair 3: Logistic Regression for firms in group R1 and R2 c
Dummy variable D-roe=1 if ROEBS €R2; 0 otherwise
INTERCEPT D-roe IND EXPORT DEBT LNASSET LGDP LFNC
-11.949 2.137 0.409 -0.154 1.067 0.603 0.061 0.547
(0.004) (0.007) (0.289) (0.714) (0.183) (0.000) (0.940) (0.349)
Pair 4: Logistic Regression for firms in group R6 and R7 d
Dummy variable D-roe=1 if ROEBS €R6; 0 otherwise
INTERCEPT D-roe IND EXPORT DEBT LNASSET LGDP LFNC
-9.787 0.056 0.019 0.319 0.520 0.155 0.717 0.074
(0.000) (0.574) (0.847) (0.015) (0.044) (0.002) (0.001) (0.637)
The first pair sample (R2 vs R3) is the firms with ROEBF 1% lower than zero versus firms with
ROEBF 1% higher than zero; result shows that firms in small negative ROEBF group have higher
probability to receive fiscal transfer than small positive ROEBF group;
The second pair (R5 vs R6) is the firms with ROEBF 1% lower than the right offering threshold and
1% higher than the right offering threshold; result shows that firms with ROEBF slightly lower than
right offering threshold are more likely to receive fiscal transfer than firms with ROEBF slightly higher
than right offering threshold.
For the third pair, the result shows that firms in small negative ROEBF group are more likely to receive
fiscal transfer than large negative ROEBF group.
The result for the last pair firms with ROEBF slightly below the right offering threshold are more likely
to receive fiscal transfer than firms with ROEBF far below the right offering threshold.
Appendix 3 Timing of the fiscal transfer decision
Sample with End year Fiscal Transfer only
Total Sample (Excluding firms with DFTM=1 and DFT=1) Total Sample
Observations 4825 3610 4825
Dependent Variable DFTEa DFTEa DFTMa
Percentage of Fiscal transfer 32.75% 22.74% 20.64%
Estimate p-value Estimate p-value Estimate p-value
INTERCEPT -7.771 (0.000) -8.689 (0.000) -7.842 (0.000)
INCIPIENT_LOSS 1.791 (0.027) 1.743 (0.044) 0.402 (0.467)
CLEAR_LOSS -0.089 (0.539) -0.167 (0.347) -0.013 (0.936)
INCIPIENT_RIGHT 1.435 (0.000) 1.342 (0.000) 0.731 (0.000)
CLEAR_RIGHT -0.340 (0.000) -0.411 (0.000) -0.283 (0.001)
IND 0.095 (0.269) 0.042 (0.695) 0.089 (0.364)
EXPORT 0.157 (0.155) 0.185 (0.171) 0.039 (0.761)
DEBT 0.751 (0.000) 0.916 (0.000) 0.459 (0.061)
LNASSET 0.135 (0.001) 0.042 (0.415) 0.277 (0.000)
LGDP 0.553 (0.003) 0.916 (0.000) 0.078 (0.724)
LFNC 0.041 (0.760) -0.245 (0.130) 0.391 (0.012)
FTMit=The Fiscal transfer received by firm i in year t reported in the interim report;
DFTMit＝Dummy variable, equals 1 if FTMit >0; 0 otherwise;
DFTEit＝Dummy variable, equals 1 if FTit-FTMit>0; 0 otherwise;