Equilibrium Consequences of Corruption on Firms: Evidence from China’s Anti-Corruption Campaign

We use China's recent anti-corruption campaign as a natural experiment to examine the (market expected) equilibrium consequences of (anti-)corruption. We argue that the announcement of inspections of provincial governments by the Central Commission for Discipline Inspection (CCDI) on May 17, 2013 represents a significant departure of past norms of anti-corruption campaigns, and thus serves a rare empirical opportunity to examine the equilibrium effects of anti-corruption campaigns for firms. We first present a conceptual framework to illustrate the channels through which anti-corruption actions can influence firms. Using an event study approach and May 17, 2013 as the event date, we find that, overall, the stock market responded positively to the announcement of strong anti-corruption actions. The announcement returns are significantly lower for luxury-goods producers, and SOES, large firms, or politically connected firms earn lower returns than private, small, or non-connected firms. We also find that existing local institutions play a crucial role in determining the announcement returns across firms. Moreover, a long-term difference-in-differences analysis shows that higher returns during the event window are associated with more subsequent entries of new firms and faster expansions of existing firms. Finally, we also provide direct evidence consistent with the endogenous grits effect.