Does Local Government Debt Affect Corporate Innovation Quality? Evidence from China

This study investigates the impact of local government debt levels on the behavior of individual firms, which is crucial for understanding the systemic risks associated with local government debt and fostering economic vitality. Using data from publicly listed companies on the Shanghai and Shenzhen stock exchanges between 2013 and 2022, this study empirically examines the effect of local government debt on corporate innovation quality. The findings demonstrate that local government debt expansion has a significant negative impact on corporate innovation quality. The negative impact remains robust across endogeneity tests and multiple robustness checks. Channel analysis indicates that as local government debt increases, innovation subsidies and procurement funding led toward firms’ decline, while both tax and non-tax revenue demands indicated firm increases. This resource reallocation contributes to the observed decline in corporate innovation quality. Further heterogeneity analysis reveals that regions with lower levels of government intervention and fiscal pressure exhibit a smaller negative effect of local government debt on innovation quality. Finally, examining the economic outcomes reveals that the decline in innovation quality, resulting from current local debt expansion, significantly reduces total factor productivity and firm value in the subsequent year, posing challenges for sustainable corporate development.