The Unintended Consequence of Discipline Inspections as an Anti-Corruption Tool on Managerial Incentives

Abstract

Since 2013, the Chinese government, as the controlling shareholder of state-owned enterprises (SOEs), has implemented "disciplinary inspections" as part of a sweeping political anti-corruption campaign targeting SOEs. Our analysis reveals a significant trade-off with this policy: while inspections effectively reduce managers' moral hazard, they also instill fear among managers, discouraging investment activities and thereby worsening corporate performance. We find that managers substantially reduce investment, leading to notable declines in profitability, innovation, and Tobin’s Q, alongside reductions in R&D expenditures and private perquisite consumptions. This effect is particularly pronounced for SOE managers lacking equity holdings or incentive-based compensation, as fear of scrutiny deters them from pursuing risky yet potentially value-enhancing investments. Our findings underscore the complex trade-offs between regulatory enforcement and managerial incentives, shedding new light on the unintended economic consequences of anti-corruption initiatives in politically connected firms.

Keywords: Managerial incentives, political connections, state ownership, corporate investment