Governmental role conflicts and corporate overinvestment: Evidence from a regression discontinuity design

This paper examines the potential conflicting role that local governments play in China as shareholders of state-owned enterprises (SOEs) and tax collectors using a regression discontinuity design (RDD) to analyze how changes in motivation for corporate tax avoidance affect investment efficiency. Chinese reform featuring the sharing of income tax revenue establishes a 40 %–60 % income tax revenue sharing ratio between the local and central governments. Accordingly, we find that when the local government's ownership percentage in local SOEs exceeds 40 %, tax avoidance becomes more advantageous for retaining after-tax profits or increasing free cash flow locally to support local development. The change in motivation for tax avoidance will fuel corporate overinvestment. Further study indicates that local SOEs serve as an additional financial resource for the local government, supporting the local economy through overinvestment in exchange for tax incentives and tax avoidance opportunities provided by the local government. This phenomenon is more pronounced in areas with severe fiscal deficits and in companies with greater tax avoidance space. Additionally, cash dividends, as a type of cash method, can partially supplement noncash methods of overinvestment. The study contributes to the literature on the impact of role conflicts under dual roles of tax collection and shareholder on corporate behavior, providing valuable insights into optimizing tax systems and fiscal policies in transitional economies.