Vertical Integration, Institutional Determinants and Impact: Evidence from China
Joseph P. H. Fan
The Chinese University of Hong Kong (CUHK) - School of Accountancy
Shanghai University of Finance and Economics
National Bureau of Economic Research (NBER); University of Alberta - Department of Finance and Statistical Analysis
Bernard Yin Yeung
National University of Singapore - Business School
February 28, 2008
In environments where the legal system and market disciplinary forces are weak to enforce contracts, vertical integration is a means to overcome transaction difficulties. Yet, these weak institution environments are also characterised by high government interventions and even corruption. Vertical integration can be a means to deal with these burdens or to enhance rent-seeking. These variations in motive for vertical integration lead to nuance in the contribution of integration to firm value and to the overall economy.
China offers a suitable background for empirical examination of these hypotheses: her legal and market institutions are often weak but there are substantial variation across sub-regions. Using Chinese data, we find that vertical integration is more common in regions with weaker legal protection for property rights, poorer local government quality, and greater direct government involvement in the economy. Moreover, companies led by insiders with political connections are more likely to be vertically integrated.
Vertical integration is weakly associated with firm value if the top corporate insider is not politically connected. It is negatively associated with share value if the top corporate insider is politically connected, but positive associated with share value if the firm is independently audited. Finally, integration by non-connected firms is associated with growth in per capita GDP while the opposite is true for integration by the politically connected, which validates the rent-seeking nature of these integrations.
Number of Pages in PDF File: 54
Keywords: Vertical Integration, Rent seeking, Property rights, Government quality
JEL Classification: L22, P14, G38, P16
Date posted: March 5, 2008