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

77 Pages Posted: 1 Mar 2022 Last revised: 26 Jul 2022

See all articles by Zhiguo He

Zhiguo He

University of Chicago - Finance

Guanmin Liao

Renmin University of China - School of Business

Baolian Wang

University of Florida - Department of Finance, Insurance and Real Estate

Multiple version iconThere are 2 versions of this paper

Date Written: July 21, 2022

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, starting in 2010, regulators evaluating SOE performance switched from using return on equity (ROE) to economic value added (EVA). 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 indeed responded 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.

Keywords: CEO compensation, Capital budgeting, Cost of Capital, Corporate governance, Economic reform, Transition economy

JEL Classification: G31, G34, M12, M52, P31

Suggested Citation

He, Zhiguo and Liao, Guanmin and Wang, Baolian, What Gets Measured Gets Managed: Investment and the Cost of Capital (July 21, 2022). Available at SSRN: https://ssrn.com/abstract=4022862 or http://dx.doi.org/10.2139/ssrn.4022862

Zhiguo He

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://www.zhiguohe.com

Guanmin Liao

Renmin University of China - School of Business ( email )

No. 59 Zhongguancun Street, Haidian District
Beijing, Beijing 100872
China

Baolian Wang (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

314 Stuzin Hall
Gainesville, FL 32611
United States

HOME PAGE: http://www.wangbaolian.com

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