Tunneling or Not? The Change of Legal Environment on the Effect of Post-Privatization Performance

Abstract

Motivated by Hoff and Stiglitz (2004)’s theory, we examine empirically how the creation of "rules of the game" affect the behavior of economic agents in a transition economy. Using a sample of Chinese state-owned enterprises (SOEs) in which controlling ownership was transferred to private acquirers between 1994 and 2006, we find that the post-privatization performance (PPP) of firms depends on institutional factors. Before 2003, we observe severe post-privatization tunneling behaviors by acquirers and worse PPP. However, from 2003, when the State issued regulations against tunneling and strengthened enforcement, the incidence of tunneling behaviors declined and PPP improved. We find that better implementation of ownership transfer and more prior experience of private acquirers are key factors that contribute to the improvement.

Keywords: tunneling, privatization, investor protection, law and finance, ethics

JEL Classification: G34, M13, N25, N45