The Role of Agency in Mitigating Expropriation: Firm-level Evidence from Contract Renegotiations

Firm-level bargaining outcomes of contract renegotiations between the bureaucrat CEOs of Chinese state controlled firms and minority shareholders prompted by an exogenous policy shock in China in 2005 reveal that poorer quality local bureaucracies are less likely to expropriate. Minority shareholders appear more able to avoid being expropriated when the bureaucrat CEO is open to economic capture. Bureaucrat CEOs are shown to respond to private benefits in the bargaining game and their responsiveness to private benefits is greater when the local government—i.e. their employer—is low quality. The findings suggest that agency problems within the public sector restrain government's ability to exercise unilateral power. Since government inefficiency is known to be correlated with government corruption, this effect can serve to mitigate the negative relationship between poor quality vertical institutions and economic outcomes.