SOE Inspections and Corporate Policies in China

Using firm-level data from China we find that inspections of central SOEs have significant impact on the investment and performance of the controlled companies. Companies controlled by indicted SOEs invested less, experienced lower performance but allocate more resources toward ‘social’ objectives in the aftermath of the inspection. To rationalize these findings and to study the implications of inspections for allocation efficiency, we propose a dynamic model with repeated moral hazard with two types of productions: market and social production. Although inspections could be instrumental to achieve social goals, they also carry some costs. We also investigate the effectiveness of how alternative corporate policies toward central SOEs such as managerial monitoring and tenure.