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What Gets Measured Gets Managed: Investment and the Cost of Capital

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  • Zhiguo He
  • Guanmin Liao
  • Baolian Wang

Abstract

We study the impact of government-led incentive systems by examining a staggered reform in the Chinese state-owned enterprise (SOE) performance evaluation policy. To improve capital allocative efficiency, in 2010, regulators switched from using return on equity (ROE) to economic value added (EVA) when evaluating SOE performance. This EVA policy adopts a one-size-fits-all approach by stipulating a fixed cost of capital for virtually all SOEs, ignoring the potential heterogeneity of firm-specific costs of capital. We show that SOEs did respond to the performance evaluation reform by altering their investment decisions, more so when the actual borrowing rate was further away from the stipulated cost of capital. Our paper provides causal evidence that incentive schemes affect real investment and sheds new light on challenges faced by economic reforms in China.

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  • Zhiguo He & Guanmin Liao & Baolian Wang, 2022. "What Gets Measured Gets Managed: Investment and the Cost of Capital," NBER Working Papers 29775, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:29775
    Note: CF DEV
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    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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