M&A and Corporate Consolidation: A Study of the Role of Competitive Government Behavior [1st ed.] 9789811566745, 9789811566752

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M&A and Corporate Consolidation A Study of the Role of Competitive Government Behavior Fengrong Wang

M&A and Corporate Consolidation

Fengrong Wang

M&A and Corporate Consolidation A Study of the Role of Competitive Government Behavior

Fengrong Wang Shandong University Jinan, Shandong, China

This book is the result of a co-publication agreement between Social Sciences Academic Press and Palgrave Macmillan based on a translation from the Chinese language edition: 政府竞争视角下的企业并购与产业整合研究 © Social Sciences Academic Press, 2016 All Rights Reserved ISBN 978-981-15-6674-5    ISBN 978-981-15-6675-2 (eBook) https://doi.org/10.1007/978-981-15-6675-2 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Singapore Pte Ltd. 2021 Jointly published with Social Sciences Academic Press. This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publishers, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publishers nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publishers remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Singapore Pte Ltd. The registered company address is: 152 Beach Road, #21-­01/04 Gateway East, Singapore 189721, Singapore

Contents

1 Introduction  1 2 Government Competition, M&A, and Corporate Consolidation: A General Analysis 17 3 M&A Waves in China: A Survey from the Government Behavior Perspective 73 4 The Mechanism of M&A Under the Impact of Local Government Competition: Models and Empirical Studies175 5 Corporate M&A and Corporate Consolidation Under Government Competition: Regional Specialization and Industrial Agglomeration255 6 Government Competition and Intra-industry M&A: Studies on Micro and Macro Performances345 7 Government Competition and Conglomerate Merger: Performance Extension Studies from the Perspective of Life Cycle Theory405 v

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8 Conclusions, Suggestions and Prospects459 Bibliography489

List of Figures

Fig. 2.1 Fig. 3.1 Fig. 3.2 Fig. 3.3 Fig. 3.4 Fig. 3.5 Fig. 3.6 Fig. 3.7 Fig. 3.8 Fig. 3.9 Fig. 3.10 Fig. 3.11 Fig. 3.12 Fig. 3.13 Fig. 3.14

M&A and corporate consolidation from the perspective of government competition: a new analysis framework 64 Number of corporate M&A in the US in the third to fifth M&A waves 75 Total amount of US corporate M&A in the third to fifth M&A waves76 Number of corporate M&A in China 78 Total amount of corporate M&A in China 79 Average transaction amount of corporate M&A in China 80 Number of corporate M&A in China (after smoothing) 83 Total amount of corporate M&A in China (after smoothing) 83 Filtered movement of the number of China’s overall M&A events84 Filtered movement of total transaction volume of China’s overall M&A events 84 China’s GDP growth rate from 1994 to 2012 87 Analysis framework for the local SOE control rights transfer under regional public governance 99 Number of enterprises in various industries listed in the A-share market from 2003 to 2012. (Data source: Collated from the relevant data of CSMAR database) 113 Sum of total assets of the enterprises in various industries listed in the A-share market from 2003 to 2012. (Data source: Collated from the relevant data of CSMAR database) 113 Regional distribution of local state-owned listed companies control rights transfer from 2004 to 2012 133

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List of Figures

Fig. 3.15 Quantity trend of RTO transactions in China’s Shanghai and Shenzhen A-share markets. (Data source: Collated from the relevant data of CSMAR database and RESSET database) 149 Fig. 4.1 Distribution of the combination of tax burden and the regional environment score of each province 223 Fig. 4.2 The number of different kinds of M&A from 2002 to 2005 and from 2006 to 2009 246 Fig. 4.3 The amount of M&A in each year before and after the environmental regulations 246 Fig. 5.1 Movement of industrial structure similarity coefficient in the three major economic zones 271 Fig. 5.2 Provincial mean of Krugman specialization index in China in 1999–2010285 Fig. 5.3 Krugman specialization index by region 296 Fig. 5.4 Relative effective tax rate of foreign-funded enterprises by region298 Fig. 5.5 Relative stock of national development zones by region 298 Fig. 5.6 Number of M&A of listed state-owned enterprises in manufacturing industry. (Data source: CSMAR database) 327 Fig. 5.7 Amount of listed SOE M&A in manufacturing industry (Unit: 100 mln yuan). (Data source: CSMAR database) 329 Fig. 5.8 Industrial concentration ratio (ACR4). (Source: RESSET database)330 Fig. 5.9 Industrial concentration ratio (ACR8). (Source: RESSET Database)331 Fig. 5.10 Industrial concentration ratio (HHI). (Source: RESSET Database)332 Fig. 5.11 Manufacturing industry profit variation (Unit: 100 mln yuan). (Source: RESSET Database) 333 Fig. 5.12 ROE of the manufacturing industry (Unit: %) 334 Fig. 6.1 2000–2009 marketization index of China’s provinces, municipalities, and autonomous regions. (Source: China’s Marketization Index: Report on the Development of Marketization in Various Regions NERI Index of Marketization of Chin’s Provinces 2011 Report)363 Fig. 6.2 Trend for regional concentration of high-tech industry 396 Fig. 7.1 Trend of conglomerate merger in the representative industries 449

List of Tables

Table 2.1 Table 3.1 Table 3.2 Table 3.3 Table 3.4 Table 3.5 Table 3.6 Table 3.7 Table 3.8 Table 3.9 Table 3.10 Table 3.11 Table 3.12 Table 3.13 Table 3.14 Table 3.15 Table 3.16 Table 3.17 Table 3.18 Table 3.19 Table 3.20

Evaluation index system of local government competitiveness in China 53 DF test results of three variables 80 AR (2) results of the three variables 80 Three-variable AR (1) residual term autocorrelation test 81 Smoothed data descriptive statistics 82 Test of China’s overall M&A transaction volume trend 86 Test of China’s overall M&A transaction trend 86 China’s two waves of M&A 86 Correlation analysis of China’s overall M&A and GDP growth rate 88 Correlation analysis of China’s overall M&A amounts and GDP growth rate 88 Stationarity test of time series data 92 Transaction time and industries of samples 105 Definition and values of dependent variables 107 Descriptive analysis of data 107 Empirical results of motivations for control rights transfer 109 Industries of control rights transferred local state-owned listed companies in 2004–2012 132 Comparison of descriptive statistics and the mean values 139 Regression results of the models 141 Distribution of corporate ownership of sample “shell corporations”150 Sample “shell corporations” by region 151 Changes of regions in RTOs 152

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List of Tables

Table 3.21 Table 3.22 Table 3.23 Table 3.24 Table 3.25 Table 4.1 Table 4.2 Table 4.3 Table 4.4 Table 4.5 Table 4.6 Table 4.7 Table 4.8 Table 4.9 Table 4.10 Table 4.11 Table 4.12 Table 4.13 Table 4.14 Table 4.15 Table 4.16 Table 5.1 Table 5.2 Table 5.3 Table 5.4 Table 5.5 Table 5.6 Table 5.7 Table 5.8 Table 5.9

Distribution of local and non-local RTOs of shell resources of different ownership 162 Definition of variables 163 Descriptive statistics of major variables 165 Analysis of correlations between variables 166 Binary Logistic regression results 168 Return matrix of the acquirer and the target enterprise 178 Inter-regional M&A by year 220 Evaluation index system for regional investment environment 222 Meaning of analysis variables and data source 224 Descriptive statistical analysis of major regression variables 225 Tax competition, regional environment and inter-regional M&A—analysis of total samples 226 Tax competition, regional environment and cross-regional capital flow 228 Investment attraction effects of tax competition and regional environment: analysis of the relative scale of interregional M&A 232 Robustness test of the impacts of different tax burdens on cross-regional M&A 234 Tax competition and inter-regional M&A under the influence of headquarters economy 235 Statistical analysis of major variables 239 Financial expenditure competition among local governments and inter-regional M&A 240 Number of M&A of different types in 2002–2005 and 2006–2009245 Explanation of empirical variables 248 Regression results of M&A trend ①249 Regression results of M&A trend ➁249 Definition of major variables and their symbol expectation 268 Industrial structure similarity coefficients of each economic zone by year 270 Descriptive statistics of government competition variables in the economic zones 272 Unit root test of each variable 273 Model 1 and Model 2 multiple regression results 275 Descriptive statistics of government competition variables 277 Estimation results of the impact of government competition on regional specialization 293 Model estimation results by region 297 Estimation results by period 300

  List of Tables 

Table 5.10 Table 5.11 Table 5.12 Table 5.13 Table 5.14 Table 5.15 Table 5.16 Table 5.17 Table 5.18 Table 5.19 Table 5.20 Table 5.21 Table 5.22 Table 6.1 Table 6.2 Table 6.3 Table 6.4 Table 6.5 Table 6.6 Table 6.7 Table 6.8 Table 6.9 Table 6.10 Table 6.11 Table 6.12 Table 6.13 Table 6.14 Table 6.15 Table 6.16 Table 6.17 Table 6.18

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Modes and years of M&A deals 311 Multiple regression analysis of the performances of M&A 313 Statistics on distribution of intra-industry M&A in the three categories and M&A by year 314 Multiple regression analysis of performance comparison of Intra-industry M&A in the three categories of industries 316 Empirical results of industrial concentration of capitalintensive industries 317 Type and year of inter-industry M&A 318 Comparison of Tobin’s Q of industrial innovation and non-industry innovation M&A 319 Comparison of M&A performance of industrial innovation M&A and non-industrial innovation M&A 321 Correlation analysis 336 Industrial concentration ratio (acr4) regression analysis 337 Industrial concentration ratio (ACR8) regression analysis 337 Industrial concentration ratio (HHI) regression analysis 338 Manufacturing industry ROE regression analysis 339 2009 marketization index by province 371 Enterprise performance evaluation index system 374 Financial index descriptive statistics 374 KMO and Bartlett Tests 375 Extracted Sum of common factors one year before M&A 376 RTOating principal component matrix for one year before M&A 377 Factor score coefficient matrix for one year before M&A 377 Principal component score covariance matrix for one year before M&A 377 Regression analysis results 379 Indicator system of marketization index 382 Sample companies by industry 384 Micro performance evaluation indicators for M&A 385 Average tax burden of enterprises by industry 387 Industrial policy scores by industry 388 M&A performance test results under different intensity of tax competition 389 M&A performance test results under different industrial policies391 Multiple regression results of the impact of government competition on intra-industry M&A performance 393 Main regions of China’s high-tech industry concentration from 1999 to 2009 397

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List of Tables

Table 6.19 Table 6.20 Table 7.1 Table 7.2 Table 7.3 Table 7.4

Unit-root test results 398 Model regression results 399 M&A samples by year 407 Distribution of life stages of sample enterprises 408 Definition and calculation of variables 410 Comparison of enterprise characteristics indicators at different stages of life cycle 411 Table 7.5 Independent samples t-test for the stages of the enterprise life cycles 411 Table 7.6 Mean test and positive value ratio of sample enterprises at the growth stage under different government intervention415 Table 7.7 Mean test and positive value ratio of sample enterprises at their maturity stage under different government interventions416 Table 7.8 Mean test and positive value ratio of sample enterprises at the decline stage under different government interventions 418 Table 7.9 Multiple regression empirical results for M&A performance 420 Table 7.10 Robustness test results 422 Table 7.11 Division standard of industry life cycle 433 Table 7.12 Results of life cycle division of China’s industries 433 Table 7.13 Sample M&A by year 438 Table 7.14 M&A score factors 440 Table 7.15 Definition of variables and expected symbols of main variables441 Table 7.16 Test results of government intervention on M&A performance in the year of the merger 442 Table 7.17 Number of conglomerate merger in the representative industries449 Table 7.18 Variance contribution rate 452 Table 7.19 Statistics of score difference 453

CHAPTER 1

Introduction

1.1   The Questions Corporate mergers and acquisitions, or M&A, and corporate consolidation have, for nearly half a century, been one of the areas of greatest concern to economists and policy-makers. At the beginning, scholars of industrial economics made their fundamental explorations on the issues. George Joseph Stigler and Oliver Williamson have been leading scholars exploring the effects of M&A from the aspects of corporate consolidation performance and public welfares. But as the welfare effects of M&A are complicated in theory and non-convergent in conclusion, many empirical studies have been conducted on the effects of M&A performances. And these explorations mostly resort to event studies and accounting information. As for the social effects of M&A, discussions are mostly carried out following diverse M&A models (Barros 1998; Yoshio Kamijo and Yasuhiko Nakamura 2009), M&A types (Julia et al. 1996), and the impacts of M&A policies (Khemani and Shapiro 1993, with remarkable research results achieved. In response to the waves of M&A in China, studies on M&A theory and empirical studies on M&A have flourished, making the field a thriving branch of research. Many scholars, focusing on the aspect of enterprises, study the mechanism and micro effects of corporate consolidation using event studies and accounting information. And from the aspects of M&A and industrial market structure, helpful explorations have been made by Gao Feng et al. (2001), Fan Conglai and Yuan Jing (2002), Liu Yu (2008), and Wen Haitao (2010). © The Author(s) 2021 F. Wang, M&A and Corporate Consolidation, https://doi.org/10.1007/978-981-15-6675-2_1

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As a mode of stock resources allocation, corporate M&A is internally driven by an institutional environment. In economic transitions, the conducts of governments, particularly government competitions, are key factors affecting M&A and corporate consolidation. Li Shanmin (2006), in the light of local government intervention, has carried out studies on value issues like restructuring through M&A and diversified M&A. Pan Hongbo (2008) has made empirical and normative studies on the “tunneling” and supporting effects of restructuring through M&A. Feng Xingyuan (2001) and Zhou Ye’an and Zhao Xiaonan (2002), with the paradigm of government competition, have explored the rise and progress of local government competitions in China and their positive and negative effects upon economic growth and regional economic development. On the whole, previous studies on M&A and corporate consolidation are mostly based on a mainstream economic theoretical framework, following the perfect market hypothesis. In empirical studies, the explorations on the effects of M&A are in many cases limited to the micro level. Discussions on the basis of industrial market structures mostly take industries and market structures as exogenous variables and conduct analyses of their impacts upon the conduct and timing of M&A. This book will reexamine the industrial nature of M&A from the perspective of intra-­ governmental competition and endeavor to build a corporate consolidation model and framework for analysis of the issue. It will further explore the issues concerning M&A in the process of economic transition. The results are expected to enrich and improve the relevant literature on M&A and will be of great significance to more empirical studies on intra-governmental competition and the effects of industrial economy and the performances of regional economy. Since the 1990s, corporate M&A has been an issue of great academic interest in China, socially and economically, with the country’s economy transforming from “the incremental reform” to “the stock reform.” Since 2009, ten programs for industrial revitalization and adjustments of key industries have been intensively introduced by China’s State Council and the regional governments of China, exposing the significant role M&A can play as a means for corporate consolidation and the market structure optimization in the aspects of policy-making and economic performance. “Industrial concentration” driven by governments has become a striking feature of a new round of corporate M&A in China. But a definite fact concerning the issue is the rise of local protectionism, market segmentation (Zhou Ye’an 2003; Bai Chong’en et  al. 2004a, b) brought by

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intra-­governmental competition in the period of economic transition, and the regional industrial “homogenization” and industrial “decentralization” in corporate M&A (Jiao Guohua 2009; Wang Fengrong, Ren Meng, Zhang Fusen 2011). Then, against the backdrop of economic transition, what has been the motivation and mechanism of government actions, especially government competition, involved in M&A? and what has been the working mechanism and effects of government competition in seeking ways for corporate consolidation and in reshaping market structure and industrial structure? How can the allocation of resources be rationalized and optimized? Empirical studies on these issues will be of practical significance for a better understanding of the mechanism and effects of the interaction between government and market in resource allocation and the rectification of local government competitions. They can clarify the direction for industrial growth under the existing systems and provide empirical references for the transformation of economic growth pattern.

1.2   Definitions of Key Concepts 1. Government and Local Governments In economics, the term “government” derives from homo economicus. Scholars, with Adam Smith at the head, have interpreted man as homo economicus pursuing the maximization of their self-interests. Though the hypothesis basically manifests the principles of human activities, it has its own grave defects. On this basis, new institutionalism has revised the assumption about economic agents and changed the hypothesis of the agents’ complete rational behaviors into bounded rational behaviors, making the premise of behaviors for economic agents more reasonable. Later on, scholars of public choice theory use the revised reasonable person hypothesis to explain government conducts and believe that the government, as the agent of public interests, also meets the behavior hypothesis of maximizing the self-interests in itself and the individual officials. Among them, Niskanen (1971), through its probes into the behavior motives and the external environment of government officials, has established a theory of monopoly and bureaucracy economy, concluding with the proposition that the government will pursue budget maximization. It believes that the government, in its social process, also plays the role of homo economicus, although the government is not representing a single person, but a

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behavioral agent embodying various interest subjects. From this, the results of government’s “public choices,” like those choices of enterprises, are the results of gaming among all interest subjects. Unlike the public choice theory, the classical economics likens the government to a “black box,” holding that the government is the “night watchman” of the market economy, “the almighty charity organization” addressing market failure at zero cost, the general representative of all people and social interests without its own independent benefit target, and a kind of “paradise model.” The institutional economists, employing the theory of public choice, take the government as a reasonable person seeking the maximization of its own interests, and, by bringing the government down to earth from paradise, stress that the goal of government actions is to maximize its own benefits. In this book, the concept of government is defined in the light of institutional economics. The government, as an economic organization, has as its own goal to maximize its own interests. But unlike economic organizations in the common sense, its objective function is multifaceted. The local governments, as essential components in government systems, have their own interests as well, which involve the public interests in the jurisdiction, the interests of the local government departments, and the individual interests of the local government officials. In short, the government represents not only public interests, but public interests at various levels and of diversified value orientations. Meanwhile, with the changing restraint conditions and incentives for government conducts, the objective functions of local government conducts will have to make corresponding adjustments. 2. Government Competition Government competition can be traced to the assumption of “foot voting” in Tiebout (1956). Albert Breton (1998) has put forth the concept of competitive government, and Wallace E. Oates (1999) has gone further and presented the Leviathan model of government. He Mengbi (2001), establishing “an analysis model for competitive government,” has generalized three conditional frameworks for making analysis of government competition, that is, the initial structure condition, political mechanism and culture, and foreign trade relations, pointing out that government competition may be divided into horizontal competition and vertical competition, or in other words, there exist competitions between local

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governments and governments at a higher level in respect to resources and control power, and also competitions between government organizations on the same level. Following the analysis model of competitive government by He, Feng Xingyuan (2001) has stated that government competitions are to a large extent institutional competitions, there being a contention for tangible and intangible resources among different government organizations. Wolfgang Kasper and Manfred E. Streit have carried out studies on transnational government competitions from the perspective of institution, believing that the concept of institutional competition highlights the internal rules system and the external rules system of a nation and has a significant impact upon the cost level and international competitiveness of a nation. Thomas Apolte (1999) has also raised the point of government competition being a competition of institutions. It holds that there are many problems existing in political vote competition. Supplementary mechanisms are expected to be added to the vote competition through institutional competition so that the citizens in a certain jurisdiction can effectively exercise supervision over the administrators. So the drive for institutional competition derives on the one hand from the supervisory pressure of citizens in the jurisdiction and on the other from the competition with other jurisdictions. Yang Hutao (2006) explores the influence of institutional changes on government competition and puts government competition into three kinds. One, government competition is for grabbing scarce productive resources. Two, government competitions are the local governments’ attitudes toward capitals and services beyond their own jurisdictions and their regulatory measures for strengthening their own advantages under “the federal system.” As it is hard to measure the market admittance policy and the effective tax burden, this kind of government competition is also referred to as “covert government competition.” Three, government competition is the general appraisal on the performance of local governments based on the policy information of other administrative regions by citizens of a certain administrative division. The process has impacts on the migration of citizens and can drive the politicians for better work. Government competition of this kind is the government competition brought up by Albert Breton. The above discussion sums up the intension of government competition from various viewpoints. The concept of government competition we are adopting in this book refers to the transnational or transregional

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competitions staged among governments in different countries or among the regional governments in a country for attracting productive factors like capital, technology, talents, and for providing public goods or public services in the fields of investment environment, government performance, and institutional innovation. Under China’s framework for transitional economy, the competitions between local governments have been interregional competition driven by incentives, fiscal and political, brought by the central government with the institutional supply mode, generally unfolding around the resources. And their specific performances are of two kinds: one is to attract the inflow of essential factors of production, and the other is to prevent the outflow of local productive factors. As government competition is an interactive concept, we will use in some chapters of the book concepts with a broader sense like “government intervention” or “government conducts” on the ground of changing views and the limitation of empirical data. For the definition of “government intervention,” the interpretation in the past studies is diversified. The Chinese version of The New Palgrave Dictionary of Economics ( 新帕尔格雷夫经济学大辞典) has interpreted the English term “regulation” as “管制” (meaning “management and control”), and its antonym “deregulation” as “放松规章限制或放松管制” (meaning “loosen regulatory restrictions or loosen control”). In some classic dictionaries of economics, government regulations refer to all acts of government policy decisions for exercising restraints over the pricing, marketing, and production of enterprises, including, for example, the control over the pricing level and the setting of standards for products and service quality. This book, based on the current situation in China, holds that government intervention can be regarded as a collective term for all government activities where governments, under the market economy condition on the ground of market mechanism, regulate the conducts of economic agents to redress, improve, and remedy market defects through macro indirect control and micro direct control under the laws and policies. Theoretically, all government conducts that may influence the acts of economic agents fall into the category of government intervention. 3. Corporate M&A Corporate M&A is an economic phenomenon in the modern market economy. It first emerges in the operation of a capitalist market economy and has been the most important mode of economic activities for the

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centralization of capital. Karl Marx was the first to foresee the trend for capital centralization and the irresistible mergers and acquisitions in capitalist enterprises when he observed that the splitting up of the total social capital into many individual capitals or the repulsion of its fractions one from another is counteracted by their attraction. This is centralization proper, as distinct from accumulation and concentration. From a micro (the enterprise) point of view, mergers and acquisitions is a mode for the external development of an enterprise (Wang Fengrong 2002). Specifically, there are two types of corporate mergers and acquisitions: merger and acquisition. Acquisition refers to the legal act where a company exercises the control of a target company by acquiring all or part of the shares of the target (the acquired company). Based on what is acquired, acquisition can be classified into stock acquisition and asset acquisition. Merger refers to any transaction through which two or more than two entities merge to form an economic unit. The common ground of merger and acquisitions is to from an economic unit in the end. The difference between them lies in that merger means the formation of a new entity by the merging of two or more units, while, through acquisition, the acquired party is incorporated into the company system of the acquiring party and rarely is the case that the acquiring company has no structural changes after the merger of the acquired company; therefore, acquisition is often seen as a kind of merger. As the motivation and principles are similar in merger and acquisition, and acquisition is an important mode and means of merger, so they are often pooled together and referred to as mergers and acquisitions, or M&A for short. From a macro point of view, M&A is the reallocation of stock capital and is also a micro process of capital flow in regions and industries; thus, M&A has effects on both the regional economy and the industrial economy. This book, merging the macro and micro perspectives of M&A, explores on the one hand the occurring mechanism and the influence factors of M&A from the industrial point of view, and on the other hand studies the corporate consolidation and regional economic effects of M&A, with the latter being the emphasis and our original idea. 4. Corporate Consolidation In contrast to the many in-depth discussions on corporate M&A, studies on corporate consolidation are fewer. As of today, there has been no consensus on the definition of corporate consolidation. Lyu Lachang

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(2004) observes that corporate consolidation refers to the process where advantageous and leading enterprises and corresponding industrial structures, with big corporations and enterprise groups as their core, are formed through the reallocations of the transregional and cross-ownership productive factors in industries to achieve a long-term competitive edge on the ground of the laws for industrial development. Yang Jianwen holds that corporate consolidation is a process featuring the division of production and specialization, aiming at the realization of effective coordination among big and medium and small businesses in an industry to improve its core competitiveness and international competitiveness through cooperative competition. The definitions above specify the goal of corporate consolidation as to gain a kind of competitive edge, though in different approaches, one through the reallocation of productive factors, and the other through the cooperative interaction between enterprises. Corporate consolidation in the general sense means a process from decentralization to centralization at two levels. At the meso level, corporate consolidation is a process to realize the optimizing, upgrading, and reallocating of resources in an industry. It embodies two dimensions: regions and industries. At the macro level, corporate consolidation is a process for the effective disposition of the internal factors of an industry. The two levels are complementary and unite to give corporate consolidation a relatively comprehensive definition. This book, taking the logic and empirical studies into account, will place particular emphasis of corporate consolidation on the meso level and regard corporate consolidation as a phenomenon when at a certain period large scales of M&A occur and bring about the optimization and upgrading of industrial structure, leading the industry from decentralization to centralization. In empirical analysis, the book, out of the necessity for comparative analysis, will survey the corporate consolidation (M&A) effects at the industrial level.

1.3   Research Framework and Contents Based on the paradigm of government competition, this book, starting from the inherent issues of M&A in the economic transition period in China, explores the working mechanism and performance of M&A on the development of industrial economy and regional economy, taking as the logic thread “the existence of M&A wave—the occurring mechanism of

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M&A under government competition—the process of corporate consolidation under government competition—the macro and micro effects of M&A.” Meanwhile, with “motivations for government competition— conducts of government competition—effects of government competition” as an invisible line, the book sheds lights on the changing paths and impact mechanism of government competition. The analysis for government competition is manifested in the logical framework of M&A and corporate consolidation. The book consists of eight chapters. Chapter 1 is Introduction. It raises the questions, lays out the basic concepts, states clearly the contents, framework for analysis, and methodology of the project, and points out the originality and significance of the work. Chapter 2 gives a general analysis of government competition, industrial M&A, and corporate consolidation. The chapter, starting from the delimitation of the theoretical framework for the book, tries to set up an analysis framework for the research based on a survey and review of the literature on government competition, M&A, and corporate consolidation. It provides a theoretical framework and serves as a basis for further discussions in the following chapters. Chapter 3 is a survey of the waves of M&A in China from the perspective of government conducts. It discusses, deductively and empirically, the support and restraint effects that government behaviors, especially government competition, in an economic transition period, can exercise on the waves of M&A and typical cases, that is, the privatization of local state-­ owned enterprises (SOEs), the connectivity of local SOEs with the state-­ owned enterprises directly under the central government (the central SOEs), and the reverse takeovers (RTOs). Or this section can be said to be a part devoted to the study on the motivation of government behaviors on M&A. This chapter provides a general description of the background for discussions in the following chapters. Chapter 4 deals with the construction of a model of M&A occurrence mechanism under government competition and gives empirical analysis with the model. Corporate M&A is in nature a game play between both parties involved in the transaction focusing on pricing and M&A strategies. The chapter first introduces the M&A model of government behaviors using the cooperative gaming method on the basis of the Cournot model. And in this context, the chapter further includes an endogenous M&A model under regional government competition to explain the impact mechanism the local government conducts may have on the

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occurrence of M&A of local SOEs. Next, an exogenous model for M&A under regional government competition is also set up from the perspectives of tax competition, expenditure competition, and institutional competition to carry out quantitative examination and evaluation of factors affecting the occurrence of M&A. Chapter 5 provides studies of the effects of corporate consolidation through M&A against the context of government competition from the perspective of the regional economy. It first explores the relation between government competition and regional industrial structure to explain the impact mechanism of government competition on regional specialization based on an extended yardstick competition model. And on this basis, the study focuses on the industry path of SOE M&A and their effects on market structure and industry structure, and carries out empirical analysis of the relation between M&A and industrial agglomeration. Chapter 6 is an exploration on government competition and the macro and micro effects of intra-industry M&A. On this basis, the study carries out the measurement of M&A effects, and brings in a discussion on government competition actions and related institutional factors. First, the chapter, by taking industry or market structure as an exogenous variable, investigates the M&A effects and impact factors of relevant industries under the established market structure. This is what is called static micro effects analysis. Next, the part presents how institutional environment may exert impacts on the performance of intra-industry M&A in light of the marketization process. This is an examination of the macro factors affecting the micro effects of M&A and can lay the groundwork for an analysis of macro effects. In the end, taking industry agglomeration as an endogenous issue and from the perspective of governance, investigation is conducted, from the viewpoint of government, on the impact of M&A for the growth of industrial market structure with the regional concentration of an industry as the measurement index for macro effects. This is the dynamic macro effects analysis. Chapter 7 is an extension on government competition and the effects of conglomerate merger from the aspect of life cycle. Introducing life cycle theory, the chapter gives an analysis of the relationship between government intervention and the performance of M&A on an examination of the life cycle of enterprises and further explores the impact mechanism of conglomerate merger under government competition on the upgrading and optimization of industrial structure in the life cycle of an industry. The part also provides empirical studies on emerging industries of strategic importance, which serves as an extended investigation on the performance of M&A.

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Chapter 8 consists of the conclusion and suggestions for further studies. It sums up the previous discussions and the conclusions of empirical studies and puts forth suggestions for government participation in M&A and for promoting the optimization of market structure. It also points out the limitations of the project and offers suggestions for future studies.

1.4   New Findings and Significance of the Project 1. A new framework has been built for the analysis of corporate consolidation theory of M&A from the perspective of government competition. Previous studies on M&A and corporate consolidation are, in theory, mostly based on the framework of mainstream economics, following a full market assumption. And in empirical studies, analyses on the performance of M&A are in most cases restricted to the micro aspect. And most studies on M&A from the aspect of industry market structure take industry and market structures as exogenous variables for the analysis of their impacts on the transaction and occasion of corporate M&A. Few explorations on M&A and the growth of industry market structure have been conducted from the viewpoint of government competition. But as the government in the period of economic transition is a key adaptive agent for economic growth, we set to build up a framework for analysis of corporate consolidation through corporate M&A under the government competition in an economic transition period. In view of government competition, we start from a discussion on the nature of M&A in China in its economic transition period to explore the operating mechanism and effects of M&A on the economic structure of an industry and the growth of regional economic structure, following the thread of “the existence of M&A wave— the occurring mechanism for M&A under government competition—the process of corporate consolidation under government competition—the micro and macro performances of corporate M&A.” Meanwhile, with “the motivation for government competition—the actions of government competition—the performances of government competition” as an invisible line, the changing paths and affecting mechanism of government competition are also explored. And the analyses of government competition are manifested in the logical framework of M&A and corporate consolidation.

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2. An M&A game theoretic model for government conducts is established and new approaches for studies are put forth. M&A, in essence, is a game both parties involved in the process play around pricing and M&A strategies. This book, based on the Cournot model, and using the cooperative game theory, sets up an endogenous M&A model integrating local government competition to explore the market structure at the time when the market reaches expectation equilibrium. Starting from this, the author endeavors to build an exogenous M&A model under the paradigm of local government competition, conducting qualitative identification and examination of the impact factors of M&A in view of tax competition, expenditure competition, and institutional competition, using the measurement method. Besides, different from the past studies on the cross-section analysis of “the plundering hand of government” and “the supporting hand of government,” the book explores the time series analysis from the perspective of life cycles, enriching and expanding the theory of government intervention under the framework of law and finance. 3. The book has promoted or expanded previous studies and put forth and discussed new viewpoints. The key viewpoint of the book is that the intrinsic logic of institutional changes in China’s economic transition has decided the mechanism for government competition and its effects on M&A and corporate consolidation. Against the backdrop of China’s economic transition, the regional governments, motivated by incentives both financial and political, bear the many characteristics of manufacturers in the market. Their goals for maximizing self-benefit and regional benefits naturally determine their competitive relations with each other. The fundamental driving force for local government competitions is the regional segmentation of capital flow— attracting the inflow of capital and restricting the outflow of capital. M&A and corporate consolidation, as the mechanism for allocating inventory resources, is determined by the joint work of market and government conducts. Firstly, government competition, as an essential component for the development of marketization in China, comes as the macro motivation for the occurrence of M&A and corporate consolidation. Secondly, the regional government competition, as a key institutional factor for

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progressive reform in China, can couple with the market environment and together determine the M&A and corporate consolidation and exert influences on the performances of M&A and corporate consolidation. The performance of M&A under government competition will diversify for the different modes and paths in government competitions. In addition, the book has put forth the following viewpoints: (1) the wave of China’s M&A has been a periodic economic phenomenon activated jointly by market, economic, and institutional factors; (2) in the process of the privatization of SOEs, the shift of control power in regional governments assumes binary motivations, and the motivation is oriented from economy toward politics; (3) regional government competition has double-edge effects on regional industry specialization and interregional market integration; (4) the performances of corporate M&A and corporate consolidation under government intervention assumes life cycle diversities. The book has also tested and verified these propositions using theoretical analysis and empirical methods. 4. Based on empirical studies of large-scale samples, the book has conducted evaluations on the effects of the implementation of industrial policies by the government and has practical reference values. In 2009, taking M&A as a means for corporate consolidation and upgrading the market structure in China, the central government and all local governments of China launched the ten key industries adjustment and revitalization plan. To test and empirically study the industry performance of this policy, the book has made the explorations from two aspects. One is based on the manufacturing industry. The book explores the effects of M&A on industrial agglomeration and industrial performance quality from the perspective of M&A in SOEs. The other is based on the emerging industries of strategic importance. The book makes investigations and comparisons of the changes in the inflow of social resources into emerging industries before and after the introduction of the ten programs for revitalization and adjustments of key industries from the perspective of conglomerate merger. These vigorous and systematic empirical studies can be of practical reference values for government departments and micro industries.

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Bibliography Apolte, T. 1999. Die ekonomische konstitution eines foderativen systems. Tübingen: Mohr. Barros, P. P. 1998. Endogenous mergers and size asymmetry of merger participants. Economics Letters, 60(1), 113–119. Breton, A. 1998. Competitive governments: An economic theory of politics and public finance. Cambridge University Press. Kamijo, Y., & Nakamura, Y. 2009. Stable market structures from merger activities in mixed oligopoly with asymmetric costs. Journal of Economics, 98(1), 1–24. Khemani, R. S., & Shapiro, D. M. 1993. An empirical analysis of Canadian merger policy. The Journal of Industrial Economics, 161–177. Niskanen, W. A. 1971. Bureaucracy and representative government. Transaction Publishers. Oates, W. E. 1999. An essay on fiscal federalism. Journal of Economic Literature, 37(3), 1120–1149. Tiebout, C.  M. 1956. A pure theory of local expenditures. Journal of Political Economy, 64(5), 416–424. Bai Chong’en, Du Yingjuan, Tao Zhigang, Tong Yueting. 2004a. Local Protectionism and Industrial Concentration in China: Overall Trend and Important Factors. Economic Research Journal, (4). 29–40. Bai Chong’en, Lu Jiangyong, Tao Zhigang. 2004b. Effects of Investment Climates on Foreign Invested Firms’ Performance: Evidence from Firm Level Data Economic Research Journal, (9), 82–89 Fan Conglai, Yuan Jing. 2002. An Empirical Analysis on M&A Performance of the Public Companies of the Growing, Mature and Declining Industries. China Industrial Economy, (8). Feng Xingyuan. 2001. On Institutional Competition Among Governments. Journal of National School of Administration, (6), 27–32. Gao Feng et al. 2001. Theoretical and Empirical Study of Chinese Enterprise M & A. China Financial and Economic Publishing House. He Mengbi. 2001. Government Competition: Analytical Paradigm of the Theory of Institutional Transformation of Big Powers. Tianze Institute of Economics Internal Manuscripts Series, (1). Jiao Guohua. 2009. On Scale Preference and Adverse Concentration Phenomenon in China’s Steel Industry. D. Central South University. Julia Porter Liebeskind et al. 1996. “Corporate Reconstructing and the Consolidation of US Industry,” The Journal of Industrial Economics 44: 53–68. Li Shanmin, Zhu Tao. 2006. Can Diversified Mergers and Acquisitions Create Value for Shareholders? Management World, (3). Liu Yu. 2008. Research on Market Structure Effect of Horizontal M & A of State-­ owned Listed Companies. Securities Market Herald, (5).

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Lyu Lachang. 2004. An exploration to a few issues about the integration of industries. Journal of Guangzhou University(Social Science Edition), (8). Pan Hongbo, Xia Xinping, Yu Minggui. 2008. Government Intervention, Political Connections and the Mergers of Local Government-Controlled Enterprises. Economic Research Journal, (4). Wang Fengrong. 2002. Enterprise Growth in the Changes of Financial Institution. Beijing: Economic Science Press. Wang Fengrong, Ren Meng, Zhang Fusen. 2011. Government Intervention, Governance Environment and the Efficiency of Market for Corporate ControlEvidence from the M&A of Local Government-controlled Listed Companies. Journal of Shandong University, (2). Wen Haitao. 2010. The Performance of M&A in Industrial Consolidation Perspective. D. Beijing Jiaotong University. Yang Hutao. 2006. On the Impact Mechanism of Government Competition on Institutional Changes. China Financial and Economic Publishing House. Zhou Ye’an. 2003. Local Government Competition and Economic Growth. Journal of Renmin University of China, (1), 97–103. Zhou Ye’an, Zhao Xiaonan. 2002. On the Mode of Local Government Competition-An Analysis of the Theory and Policy for Building a Benign Competitive Order for Local Government Competition. Management World, (12), 52–61.

CHAPTER 2

Government Competition, M&A, and Corporate Consolidation: A General Analysis

The institutional changes in China’s economic transition have endogenously determined the competitions among local governments. As a mode of resource allocation, M&A and corporate consolidation represent the degree of marketization and are subject to administrative barriers and market segmentation brought about by government intervention. In this chapter, we will first review the relevant literature and the development of government competition and establish an index system for the measure of government competitiveness. And, on this basis, a new framework for the analysis of corporate M&A and corporate consolidation from the perspective of government competition will be established.

2.1   Economic Transition and Government Competition Economic transition is essentially a process of institutional changes. The main participants of institutional changes, including the central government, local governments, and non-governmental institutional bodies like enterprises, are involved in the interest relationship between the participants and the resulting benefit pattern evolution throughout the transition process. In the following, we will, against the background of the system of economic transformation, give an elucidation of the connotation and extension of government competition and the means and measures of the practice, so as to lay a theoretical foundation for the follow-up studies. © The Author(s) 2021 F. Wang, M&A and Corporate Consolidation, https://doi.org/10.1007/978-981-15-6675-2_2

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2.1.1   Government Behaviors in Economic Transition 2.1.1.1 The Connotation of Economic Transition Economic transition is, in a certain sense, synonymous to “transitional economy.” The studies of economic transition focus on China in its process of reform and opening up. And the key issues of the economic transition concern the process of China transforming from its planned economy to a market economy (Sheng Hong 1994; Fan Gang 1996). At present, a relatively classical definition of transition economy has been given by Gérard Roland (2002), which holds transition as a large-scale institutional change process, or the transformation of the economic system mode. In addition, “emerging market economy” and economic transformation are identical concepts, as the so-called emerging market economies are generally countries in the course of economic transition. Many overseas scholars will not limit their understanding of economic transition to the scope of economic system. J. Sacks holds that the existence of a system core is fundamental to economic growth, and economic transition is a process of convergence between the post-socialist state system and the global capitalist state system, meaning that the process does not lay emphasis on the reform of systems. Economic transition, in the long run, must be based upon “constitutionalism” in political theory, or else the results for the transition will not be stable. In the long run, the economic transition with the temporary state of politics far away from the market will not be successful. Jànos Kornai (2005) believes that economic transition is a systemic, multifaceted, and complicated concept. It will not be fully explained by simply taking into consideration the changes from a plan-oriented economy to a market-oriented economy. It will have to take into its analysis framework informal restraints like life style and culture and formal rules like political governance and laws and regulations.. Xu Zheng and Quan Heng (2003) believe that the understanding of economic transition in China is based on the discussions of five aspects, namely, system transition, economic patterns, the combination of economic system and the transition in social patterns, transition from traditional socialism to the primary stage of socialism, and the combination of the mode for economic growth and system reform. Hong Yinxing (2006) further proposes that economic transformation includes not only market-­ oriented transformation, but also transformation for modernization and globalization, which are key aspects of transition economics. Zhang Liang

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et al. (2006) otherwise points out that economic transformation must be based on technological progress and the interactions between the two need to be treated dialectically. It states that the economic transition in China is a complex system centering on economic progress and institutional transition. Wang Shuguang (2009), from the perspective of institutionalism, holds that economic transition should be examined from the diverse aspects of economic behaviors and stress should be laid on the long-term nature of economic transformation. And in the process, new institutional arrangements are key to the success of transition. The market economy not only requires the freedom from government regulations and the privatization of property rights, but it also requires a complete institutional framework to support its sound operation. In summary, it is not difficult to see that in the interpretation of economic transition, Chinese and foreign scholars have taken different approaches. Foreign scholars emphasize the purpose of economic transition, that is, the ultimate achievement of the convergence of the country’s political system and the global capitalist system, viewing economic transition as an all-round revolution of economy and politics. Chinese scholars lay more emphasis on the dynamics of economic transformation and explore the issue from the perspective of institutional change, emphasizing the combination of economic system and social pattern. To balance the two different approaches, “economic transition” is taken in this book as a multifaceted economic development process that focuses on institutional changes, which embodies the five aspects Xu Zheng and Quan Heng have drawn together. 2.1.1.2 The Paths and Features of China’s Economic Transition China has made tremendous achievements in its transition from a planned economy system to a market economy system. Studies have been conducted on the evolution of this economic transition from different perspectives, with emphasis laid on the division of the transition phase and the evolution of transition paths. This helps us to make better use of the common features of economic transformation and, at the same time, go into details of the complexity and diversity of economic transition. Zhao Min (2003) has proposed a four-phase model of the economic transformation in China. The first phase, from 1978 to 1991, is the phase of reform exploration and supply expansion. The prominent issues encountered in this phase of transition have been the constraints of traditional ideas of economy and the short supply of commodities, where the key

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solutions have been “emancipation of the mind, decentralization of power, and transfer of profits.” The second phase, from 1992 to 1997, is the phase for the construction of the framework for the socialist market economy and of rapid economic growth. The policy at this stage has been affected by Deng Xiaoping’s talks made on his inspection tour to Southern China and the opening of the 14th National Congress of the Communist Party of China. This phase has set “socialist market economy” as a clear goal of reform and has pointed out the orientation for economic transition. The third phase, the 10–15 years since 1998, is a period of the challenges in the difficult in-depth reforms and a period for overall adjustment of the economic structure. This phase can be further divided into two stages, the early stage and the later stage. At the early stage, the relevant institutional arrangements, economic structure, and other issues left over by history are exposed, brought about by the rapid economic growth in the previous period. In the later stage, reforms are carried out from the fundamental aspects, and breakthroughs are made to eliminate those already exposed problems and the major institutional barriers that hinder the development of the socialist market economy so as to institutionally maintain the rapid economic growth. In the fourth phase, relevant institutional arrangements have been established and improved, and efforts then should be made to coordinate and integrate relevant systems with social economy. The research team of the Macro Economic Research Institute of the State Development and Reform Commission of China (2004) has conducted studies on issues of development in the period of accelerated economic transition in China, and has roughly divided the economic transition of China into three periods: the period of spontaneous start-up (1978–1991), the period of self-advancement (1992–2000), and the period of full-speed development (starting at the turn of the twenty-first century). Zhang Huijun (2007) has proposed three important turning points in the process of economic transformation: the official launch of the transition, the irreversibility of the marketization process, and the completion of transformation. According to these three turning points, it has divided China’s economic transition process into three historical periods: the period of preparation (1978–1991), the start-up and earnest promotion period (1992–2000), and the period of deepening and completion of economic transformation (starting at the turn of the twenty-first century).

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The research team studies of 30 years’ reform of the economic system with the Chinese Academy of Social Sciences (2008) has divided the process of China’s economic transformation into the following four stages: The first stage is the start-up stage of reform (1978–1984), which is a stage of planned economy supplemented by market adjustments; the second is the expansion of reform (1984–1992), when a planned commodity economy is established; the third stage is the propulsion of reform (1992–2002), which is the phase for the preliminary establishment of a socialist market economy; the fourth stage is the phase for deepening the reform (2002 to date), which focuses on the improvement of the socialist market economic system. It is not until 1992 when Deng Xiaoping made his talks on his inspection tour to Southern China that the clear goal of establishing a socialist market economic system was set and the construction of a new economic system launched. Taking into account the different views of scholars and the actual situation of China’s economic transition, we believe that the view of the Research Team studies of the 30  years’ reform of the economic system (2008) is more convincing, and therefore we will divide China’s economic transition into the start-up stage of reform, the all-round development stage, the stage of the preliminary establishment of a socialist market economic system, and the stage of improvement for the socialist market economy system. More than 30 years of reform and opening up have initiated and contributed to the progress of China’s economic transformation, presenting the following features. (1) Phased Transition Phased transition is a typical feature of China’s economic transformation. It is not only a true portrayal of China’s economic reform, but also a practical reflection of the way of economic transformation. Reform and transformation have different goals and priorities at different stages, and the goals of economic reform will be constantly adjusted according to the demands of the reform process. The deficiency and faults in a certain phase will be corrected and improved in the next stage. Therefore, the phases are both independent and inseparable. This phased transition in China can better “solve the hierarchical arrangements of the market economic system and the orderly requirements of the reforms in terms of the speed of reform, partial reforms, and comprehensive reforms to achieve the best

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combination of reforms” (Zhang Jianjun 2008). At the same time, the characteristics of phased transition have enhanced the progressivity of China’s economic transition. The gradual institutional change model effectively avoids the involution to the traditional modes and the overall crisis of the economic system after a long-term accumulation in the transition period (Wang Shuguang 2009). Therefore, on the whole, China’s phased reforms will help improve economic efficiency while advancing the establishment of a new system. (2) Regional Differences In the vast territory of China, big differences exist in the speed of development and resources among different regions. Therefore, the country’s economic transformation will assume unique regional differences. Judging from the larger geographical scope, there are major economic transition differences in the Pearl River Delta, the Yangtze River Delta, the Bohai Rim Regions, and the old industrial bases in the Northeast; from the perspective of regions, there are also different paths for economic transitions in different regions, for example, in the Yangtze River Delta, there are the “Wenzhou model” and the “Kunshan model” (Zhang Peng 2010). Meanwhile, due to the regional differences in history, politics, and economic foundation, the economic transformation policies for each region are also distinctively different, which will directly affect the regional model and the speed of economic development. The regional differences in the process of China’s economic transformation make it impossible for us to simply lump under one model of economic transformation in all regions. As long as the regional transition policies are in line with their own requirements and can support their economic development, they are a desirable institutional arrangement. Therefore, the diversity in the regional selection of the development path during the process of economic transformation represents not only the reality of China’s economic development, but also an important factor that affects the success of China’s economic restructuring. (3) Government-Led Process Although continuous improvement of a sound market economy system is an important force for promoting institutional changes, in the path of economic transformation with Chinese characteristics, the government as

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a participant in institutional changes has always had a crucial role to play. Strong push from the government has obviously made China’s economic and social transformation a government-led process. First of all, in the gradual economic transition from bottom to top in China, the government is the maker of the transformation decision and the controller of the transformation process. In the reform process, many policies and systems are initially put forward by the people, and after the approval of the local governments, they are eventually scrutinized by the central government and then promoted as national policies. It can be seen that the successful completion of the economic transition is inseparable from the government’s decision-making and guidance. Second, the government also holds the decision to adjust the overall orientation. China’s economic transformation is a process of continuously emancipating the mind and renewing ideas, and is a game involving the interests of multiple parties and a dynamic equilibrium process. To break the existing pattern of interests requires the government’s top-level system designs and their implementation. So the government has a crucial role to play at every stage of China’s economic transformation. 2.1.1.3 The Role of the Government in China’s Economic Transition The role the government plays in the process of China’s economic transformation has been an issue of great concern. This book will treat the issue from two aspects. One is to make analysis of the government’s functions in the long-term economic operation. The other is to analyze the impact of the government on local economic growth. In these two aspects, the government plays different roles, and we will give further explanations in the following. (1) Administrators and Owners China has its unique historical background. The analysis of the government’s functions in the long-term economic operation may reveal the government has always been playing double roles—the administrator and the owner. On the one hand, the government is the administrator of economic activities, guaranteeing the sound operation of the macro economy. On the other hand, the government is also the owner of the state-owned micro economy, which facilitates its efficient development.

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As the defender of market order and public interests, the government has the right to supervise social and economic activities to maintain the stable development of the macro economy. Zhao Yuanhua (2004) believes that even in a relatively sound market economic system, due to information asymmetry, external effects, monopolies, and the existence of public goods, there will still be market failures. Moreover, China is still in its primary stage of socialist development. Its market economy system is still not mature enough and complete, and is still far less developed than that of the Western countries. As a result, the problems brought by market failure to the country’s economy will be more complex and special than those to the Western countries. Apart from the common problems such as external effects and insufficient supply of public goods, there are still property relationship confusions and serious insider control of industries. Therefore, the government’s participation in economic activities as a macroeconomic administrator is particularly important in China. For economic activities that are not in accordance with the rules and regulations, the government has the right to give them guidance and point them to a normal and regularized track to solve problems that the market cannot solve. M&A, as an important part of market economic activities, also inevitably require the participation of the government. Liang Kejian (2003) holds that the government’s appropriate participation in M&A can help take the overall situation into consideration and make corporate asset restructuring in line with national and local industrial policies, improve the efficiency of resource exploitation, ensure the sustained optimization of the industrial structure, and give full play to the government’s macro-­ control. Sun Yazhong (2011) has also pointed out that the government has abundant political resources, especially the right to allocate economic resources. The modern market economy requires that the government intervene in market operations, remedy market failures, and improve the efficiency of resource allocation. Accordingly, the government as a macroeconomic administrator has all the incentives and necessities to participate in economic activities to promote and regulate the healthy growth of the market. As the owner of state-owned assets, the government’s involvement in the economic activities of SOEs is an effective measure to increase the control of the state-owned economy and to realize the preservation and appreciation of state-owned assets. In the transition of the economic system, the modern enterprise system has not yet been fully established.

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SOEs are not yet independent and full market players. They still need the government to participate in, directly or indirectly, or lead their economic activities. Zhao Yuanhua (2004) believes that state-owned assets, like other assets, can realize maintenance and appreciation of values through economic activities such as M&A, and the owners of SOEs also have the goal of pursuing efficient asset utilization and maximizing property income. Then, corporate M&A, as one of the effective ways of realizing the sound allocation of state-owned assets, naturally require the participation of governments. Dong Fuhua (2003) has stated that by participating in economic activities such as M&A, the government will effectively promote the transition of SOEs to economic reforms, and make them achieve a harmonious coexistence with the private sectors. Liu Shaoyong (2002) thinks that the government, as the owner of state-owned assets, can effectively monitor coordination between the parties in the process of M&A of SOEs, reduce the cost of the process, and optimize the allocation of resources. For cross-regional, cross-industry, and integrated state-owned enterprises, this is particularly true as the coordination effect brought by government participation will become more apparent. This will, to some extent, increase the overall efficiency of SOEs, and provide endogenously the support for the dominance of the state-owned economy. In addition, the government can also selectively encourage or restrain the economic behaviors of relevant large-scale SOEs in accordance with national industrial policies and the strategic deployment of state-owned economy, so as to guide the flow of state-owned assets to highly effective and advantageous fields and optimize the allocation of state-owned assets, expand and enhance the control and influence of state-owned capital on social capital, promote the sustained and healthy development of the entire national economy, and realize the function of the double roles of the government. It then follows that whether as a macroeconomic administrator or as an owner of state-owned assets, the government has the incentives to participate in the economic activities of enterprises. Moreover, in the current market transition, if you want the real effects of the rules of market economy, you must rely on the state-owned economy withdrawing from the competitive industries, but the withdrawal of the state-owned economy from the competitive industries must rely on the further progress of the privatization of SOEs. As a result, it is necessary for the government to participate, directly or indirectly, in microeconomic activities in the course of the transition.

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(2) Supporters and Predators In the current period of economic transition, the government, as the administrator and owner, will inevitably interfere, directly or indirectly, with microeconomic activities. Then, our concern will also include what kind of influence the government will have on local economic growth with their participation. From this perspective, we will, according to the model of government competition, position the government as supporter and predator. For a long time, the impact of government behaviors on local economic growth has not received sufficient attention, and the specific institutional arrangements between the central and local governments formed in the economic transition have led to seriously uneven economic development in different regions. From a structural perspective, therefore, China’s economic growth does not have internal consistency. Zhou Ye’an and Zhao Xiaonan (2002) have conducted studies on the competition model of local governments in China, analyzed and compared the local government behaviors in regions with different levels of economic development, and classified local government behaviors in competition into three kinds: enterprising, protective, and predatory. The enterprising local government is committed to promoting the development of the regional economy qualitatively, so it will prefer to rationally plan local resources and actively implement institutional innovation and technological innovation. The predatory local government is committed to maximizing the utility of its own but not its jurisdiction, so it will plunder wealth from the region through hidden means such as taxation. The protective local government is in between the previous two extremes. According to Zhou and Zhao’s classifications, we define the government’s role in economic growth as supporter and predator. If all local governments adopt the enterprising mode of competition, local governments will play a role of promoter and supporter in the process of local economic growth. We call such government supporter; if local governments adopt the protective or predatory mode of competition, this may lead to vicious competition between regions, which hinders the growth of the local economy. We will refer to such governments as predators. In the studies and analyses of the effects of government behaviors, some scholars lay more emphasis on the positive role of the government in institutional innovation and technological innovation, and believe that in most cases the government plays the role of a supporter. In particular,

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since the implementation of the fiscal decentralization system, regional economic growth is associated with the promotion of local government officials, forming an internal consistency between regional economic growth and the interests of government officials, and thus the enthusiasm for local governments’ participation in and support of regional economic development has been greatly enhanced, and the local government officials have a strong impetus for promoting economic growth. Driven by such dynamics, local governments actively carry out institutional innovation and technological innovation to boost the development of the local economy and become supporters of China’s economic system transformation and economic growth. Yang Ruilong (1998) has stressed the positive role of local governments in the institutional changes in China. It emphasizes the analysis of institutional changes from the perspective of institutional supply, and in accordance with the important role played by local governments in the reform process in China, it has put forward the three-stage hypothesis of the mode of China’s institutional change, that is, institutional change is in three stages: the supply-driven changes, the intermediate diffusion changes, and the demand-induced changes. And in the stage of institutional changes of the intermediate diffusion, attention must be paid to the actions from local governments. Only through an understanding of the local governments as the primary action group can we solve the North Paradox. Therefore, institutional innovation led or participated by local governments is a Pareto improvement. Zhou Ye’an (2000) has made an analysis of the process of institutional change in China from the perspective of evolution. It believes that institutional change in China is a process of constant conflicts and coordination between internal and external rules, in which local governments play the role of institutional entrepreneurs and the central government is equivalent to judges of common laws. The local governments can realize their potential benefits through rule competition, while the central government mainly guides the reform process through the judgment of the legitimacy and externalization of internal rules. Liu Junde and Shu Qing (1996) have undertaken studies of the economy of the administrative divisions and believe that the administrative division economy has played an important and positive role in China’s economic transformation. On the one hand, scientific and reasonable administrative divisions provide a strong material basis for the rapid development of the regional economy and the maintenance of social harmony and stability. On the other hand, such practice clarifies the “property

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rights” of the administrative regions, strengthens the regional enterprise competition, and effectively maintains the market. Zhong Xiaomin (2004) holds that since the reform of tax distribution system in China, all regions, to win out in the financial competition, have on the one hand increased tax competition, and on the other hand gradually shifted the fields of competition to the provision of high-quality public goods and services. The role of fiscal expenditure competition is becoming more and more obvious, especially in economically developed regions. This also shows to some extent that the government has promoted regional development. Zhang Jun et al. (2007) believe that competitions among local governments have enhanced the “assistance” behavior of local governments, making them pay more attention to the infrastructure construction that serves the long-­ term local economy, and the construction of the extensive highway network is just a microcosm of such practice of the local governments. With great investments in infrastructure construction, the local governments have improved the public services and enhanced the local economic carrying capacity, so that non-local resources can be more productive in the local area more quickly, providing impetus for the rapid growth of the local economy. Meanwhile, the competitions between governments will also form budget constraints on the local governments and reduce the local governments’ waste of non-productive resources. These studies generally emphasize the positive role played by local governments in the process of China’s economic transition, that is, they play the role of supporters. But some scholars think otherwise. They pay more attention to the irrational practices of redundant construction and local protectionism by local governments, and believe that local government behaviors also hinder regional economic growth to varying degrees, or, in other words, the local governments here have played the role of predators. Wei Houkai (2001) believes that the driving force behind the redundant construction is the blind competition of local governments. The GDP preference of local governments will stimulate them to blindly approve the start-up of too many enterprises of similar production, resulting in excess production capacity. Therefore, the nature of redundant construction is the market failure caused by the government’s intervention in the market, and the only way out of this dilemma is the government’s putting down the authority for examination and approval of the projects. However, unreasonable repetitive construction comes from the imperfection of the investment system. Its internal institutional factor is the potential requirement of local governments for local economy growth. This

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process has been developed under the competition mode of local governments in China, and it is also rooted in  local government intervention. Zhang Keyun (2001) holds that the problem of the local redundant construction is transitive, and the industrial mismatch of one local government may lead to the intentional convergence of other local governments. The local government that produces mismatches will blindly pursue industrial raw materials when carrying out the first operation. Therefore, other local governments are stimulated to pursue raw materials in the same line. When the same raw materials lead to the same industrial output, local governments will consume a lot of resources in market segmentation. When rational local governments appear, they will use their competitive edges to cut down the price of industrial outputs. In the end, the competition for interests between local governments will lead to the “prisoner’s dilemma.” And no one can profit from the competition. Cao Jianhai (2002) has the finding that the problem of redundant construction in China comes from administrative intervention. Against the current policy background, anti-monopoly measures will weaken the interference incentives of local governments, thus effectively reducing the probability of redundant construction of local governments. Zhou Li’an (2004) has pointed out that the competition of local government officials is not only represented in terms of GDP and profits and tax. At the same time, it is also shown in the competition for promotion on “the official ladder,” where such competition for political promotion will lead to various inefficient redundant constructions and even “vicious competition.” Apart from the redundant construction, local protectionism and market segmentation have also been issues of academic interest. Yin Wenquan and Cai Wanru (2001) believe that the root of local protectionism is the inertia of local governments. After mobilizing resources to achieve economic developments, the local governments may attempt to use fewer resources to maintain its development status, thus taking protective measures for the local market. This practice will result in a waste of resources at the national level. In addition, it will form a larger market failure in the economic structure, which will make it impossible to implement the policies of the central government and greatly reduce its strength for market control. Therefore, it is not difficult to see that local protectionism and market segmentation may bring short-term benefits to local governments in the early stage. But in the long run, it will undoubtedly bring about continuous negative impacts on the local governments and even the national economy. This is mainly manifested in the following three aspects:

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(1) market signal distortion, (2) the block of the free flow of capital, and (3) anti-economic globalization. Further studies show local protectionism in China may be more acute than imagined. Wang Xiaolong and Li Bin (2002) believe that the staunch supporters of local protectionism are local governments in economically underdeveloped regions, because in market competition, these regions do not enjoy any advantage, which may evolve into a vicious circle. Lu Ming et al. (2004) have examined the behaviors of local governments in economically backward regions from a micro level and have found that market segmentation can form a certain period of slow development for some enterprises so that enterprises will not face the challenges of other enterprises in their weak period, which may stimulate the impulse of market segmentation of local governments. 2.1.2  Government Competition and the Measurement of Government Competitiveness in the Economic Transition Period On the basis of the definition of government competition in the preceding parts, this section focuses on explaining the types and means of government competition and the measurement of government competiveness. 2.1.2.1 Types of Government Competition In terms of the types, government competition can be classified into vertical competition and horizontal competition. Vertical government competition is mainly derived from the centralization and decentralization of power. Specifically, it can be subdivided into the competition between the upper and lower levels of government and the competition between the functional departments of the upper and lower levels of governments. Horizontal government competition is mainly carried out between governments over the competition for mobile factors of production and market products. It can be further divided into competitions among national governments, and between the local governments and government functional departments at the same level within a country. Thus, it is self-­ evident that all levels of government agencies have vertical competition with their superiors and meanwhile horizontal competition with their peer governments on the same level.

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(1) Vertical Competition Generally, vertical government competition can be further classified into two types: competition between upper and lower levels of government and competition among functional departments at the upper and lower levels of government. Vertical government competition mainly comes from the allocation of power, that is, centralized power and a decentralized power system. Under the traditional planned economy system, only administrative subordination exists between the local governments and the central government. The local government is only one level of organization in the administrative system. It has no independent economic management right and no corresponding social resources to control. As a result, the local government can only obey the central government in regard to rights and interests. It can be seen that under the centralized power system, all major decisions are made by the central government. The local governments are only administrative organizations that conduct and implement decisions, and only government organs that realize the overall interests of the country in accordance with the power conferred by the central government. Under such system, there is no interest game between the local governments and the central government, so there is no competition. But with the deepening of China’s marketization reform and the continuous development of democratic autonomy, the centralized government system adapted to the traditional planned economy system can no longer satisfy the needs of the country’s economic development, so the decentralization system reform has got to be implemented. Under the decentralized system, the local governments have been given a relatively independent autonomy in economic management, so that the local governments can decide and handle a series of affairs within their jurisdictions. As a result, the dominant position of local government interests has become increasingly prominent in the process of regional economic development, making local governments share the social and economic pressure for the central government in more ways. At the same time, it has also refined the central government’s economic decision-making, improved the scientificalness of local economic development, and effectively promoted the coordinated development of the national economy as in a chess game. So, in the relationship between the central government and the local governments during the economic transition period, although the local governments have not yet become legal market agents, they have to a considerable

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extent gotten rid of the traditional subordinate administration relationship with the central government and become the actual economic entities. Generally speaking, the fundamental interests of the central government and the local governments are the same. However, the central government is considering the maximization of the overall interests of the country while the local governments are considering the maximization of the interests of their jurisdictions. Therefore, in some cases, the central government will ignore the interests of the local governments for the realization of collective interests. Similarly, the local governments may also harm the overall interests for the sake of their regional interests. This leads to conflicts of interest between the central government and the local governments, and the vertical government competition between the two arises at the point. Generally speaking, the allocation of political and economic resources, the division of power, and financial transfer payments in vertical government competition are all prominent manifestations of competition. The motivations for these come from the pressure of market players and their voters who need resources, public goods, and related policy supports from the government. The local governments must provide technological and institutional platforms to meet the needs of market players and voters. Market players and voters are the foundation for the existence and development of the local governments and the source of their power. On the one hand, since the power of local governments comes from market players and voters within their jurisdiction, the governments must subject them to their restraints and supervisions, and, meanwhile, the local governments’ behaviors must reflect their wishes. On the other hand, the more resources and factors of production the local governments attract, the more resources and factors they can control, and the greater will be the corresponding actual power and political influence of the local governments. Thus, the local governments need to provide the corresponding technological platform and institutional platform, attract more factors of production to flow to regions under their jurisdiction, thus creating wealth and promoting regional economic development. And in the process, the local market players and voters also obtain various non-market supplies of public goods and public services that they need. Then under this condition and premise, the local governments’ behaviors are consistent with the interests of the local market players and voters. The local governments can also obtain corresponding political power and economic benefits.

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However, the vertical competitive relationship, whether it is between the central government and the local governments or between the upper level government and the lower level government, will be distorted by the intervention of administrative forces, making the vertical government competition lack due fairness and regulation. Even in the Western countries where the federal system is practiced, their vertical government competition relations will be more or less restricted by administrative relations. Albert Breton (1998) believes that the vertical government competition relationship is very weak, mainly because the local governments are deprived of the conditions for fair competition with the central government. The administrative system of the country determines that the local governments are in a weak position in the vertical competition relationship with the central government for a long time, thus leading to a weak vertical government competition relationship. Therefore, taking into consideration the overall situation and taking into account the local situation are the basic mode of vertical government competition, and also the basic principle of competition between local governments and the central government. Generally speaking, there will be no extreme situation. Of course, if the local government adopts extreme measures in dealing with the contradiction between the overall interests of the society and the local interests, it is likely to lead to the decline of authority of the local governments. This in turn affects the realization of the social and economic development goals in their jurisdiction and ultimately endangers the interests of the central government. Hence, the greater the autonomous management power and financial power the local governments have, the more intense the vertical government competition between the local government and the central government. In addition, for the horizontal competition between local governments, the vertical competition between local governments and the central government will also have a very important and even decisive influence. Under normal circumstances, if a local government can gain more benefits from the central government than other local governments at the same level, or, the more authority and policy space a local government can obtain, the more likely it is to gain an advantage in horizontal government competition. Thus, we see, the vertical government competition between the local governments and the central government and the horizontal government competition are interrelated and affect each other. The result of vertical government competition will directly affect the state of horizontal government competition among local governments. On the other hand, the

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outcome of horizontal competition among local governments will also effectively affect their position in vertical government competition. Therefore, the vertical competition between the local governments and the central government can also be regarded as a means and method of horizontal competition between local governments. (2) Horizontal Competition Horizontal government competition mainly refers to the competition between governments of different countries and between two or more local governments that have no subordinate relationship, which is centered on the mobile factors of production and the product market. Horizontal government competition can also be classified into competitions between national governments, between the local governments at the same level within a country, and between the functional departments of the governments at the same level. Generally speaking, the horizontal government competition we refer to here is the competition among the local governments of the same level within a country. Typically, horizontal government competition is conducted on the basis of vertical government competition, and it is a process of the optimization of the allocation of regional resources by various local governments under established power conditions. For the local governments within a country, the demanders of government services have the right to obtain government services in different regions. But the supply of government services depends on the financing capacity of the local government while the financing ability of the local governments depends to a great extent on the local tax revenue. Under this premise, local governments will compete for mobile production factors and product markets with the view to maximize regional economic benefits and realize regional development goals. Then, the specific internal drive for the long-standing horizontal competition between local governments can be summarized into three main categories: the local government’s pursuit for the maximization of their own interests; the local government’s chase for the recognition of the central government; and the local government’s pursuit for the recognition of the local social subjects. Regarding the motivation of local governments to pursue their own interests, the classical school of political economics and the rational expectation school have both made interpretations. The classical school of political economics believes that the government represents the interests of the

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ruling class and wants to win more political and economic benefits for the ruling class to maintain their dominant position. But in socialist countries, the people are the fundamental subjects of interests. According to this theory, the Chinese government should represent the interests of the people and win political and economic interests for the people. So, the government should pursue the maximization of social public interests instead of pursuing their own interests. However, there are differences between public interests and government interests. The rational expectation school has made the analysis of horizontal government competition based on the assumption of homo economicus. They have found that the government will still pursue their own interests in the course of making decisions and implementing public management on behalf of the public. The government of a socialist country falls into the same situation instead of being completely altruistic. Obviously, in order to maximize their own interests, the local governments will compete with governments at the same level, thus forming horizontal government competition. The local government’s chase for recognition by the central government is also a motivation for horizontal government competition. Before the reform and opening up, China was practicing a planned economy, and the local government was the local economic and social management organization. It can only organize and manage its jurisdiction according to the decision of the central government and had no independent decision-­making power. Therefore, under the planned economic system, there is no horizontal government competition among local governments. After the reform and opening up, with the deepening of market economy reform, the functions of the local governments are gradually changing, and the mechanism and standards for government performance evaluation have also changed. At this stage, the index for evaluation of local government performance is mainly the GDP of its jurisdiction. Therefore, the recognition of the central government is the precondition for local government officials to achieve their promotion goals, and is also the strongest motivation for horizontal competition among local governments. To accomplish excellent results in GDP within the jurisdiction, gain a higher position and prestige, and win the recognition of the central government, and realize the goal of promotion, the local governments may harm the overall interests for a rapid development of the local economy and conduct vicious competition with local governments at the same level for capital, technology, and other mobile factors of production by

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hook or by crook. Competition for this purpose will often lead to vicious competition among local governments, thus impairing the overall welfare of society. The local government’s pursuit of recognition by local social subjects is another motive for the occurrence of horizontal government competition. With the deepening of the reform of the market economy, the functions of the local government are also changing. The local government is no longer simply subordinate to the superior government, nor is it simply a local administrator, but it has gradually evolved into the social service provider in its jurisdiction. Therefore, while offering its service to the central government, the local government should also serve the local social subjects, striving to meet the various needs of the public. It has the responsibility to promote the economic development of its jurisdiction and provide attractive social welfares and public services. If the local government fails to win recognition by the local social subjects in these fields, it will face various pressures from its service objects, which will reduce its social credibility, hinder the implementation of administrative decisions, thus increasing management costs and affecting the economic development of the jurisdiction. So to gain the recognition of the social subjects in its jurisdiction, the local government must strive to develop the local economy, advance infrastructure construction, and improve its public services. And to achieve the goal, the local government may resort to all means to boost the development of the regional economy and compete with other local governments, thus leading to horizontal competition among local governments. Apart from the competitions among local governments within a country, the competition between national governments is also a kind of horizontal government competition. Compared with the competition between local governments at the same level within a country, the substance of competition between national governments is more extensive, as the competition is not only economic, but also political and cultural. The competition among local governments at the same level within a country is mainly manifested in the economy; therefore, the economic competition between different national governments has also attracted much attention. Although international economics has not explicitly defined the concept of international government competition, scholars in the field of international trade have carried out relevant studies on the economic competition of different national governments. Generally speaking, the economic competition between national governments is similar to that between local

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governments in a country. The difference is the economic competition between national governments is more intense and more diversified in modes and means. In the analysis of inter-country government competition, Douglass North, a Nobel laureate, has put forward his own views in his works The Rise of the Western World: A New Economic History, Structure and Change in Economic History and Institutions, and Institutional Change and Economic Performance. North believes the competition between governments in economic performance is ultimately the competition at the institutional level. Therefore, the government’s role is mainly reflected in its ability to provide a more efficient institutional arrangement and incentive mechanism for organizing economic activities. Later, Wolfgang Kasper and Manfred E. Streit, two scholars of new institutional economics, further developed North’s ideas and believe that a country’s systems consist of internal and external rules. Among the rules, the internal rules evolve with experience within the group, while the external rules are designed outside the group, and the external rules are mainly rules imposed on society through political conducts. Then, among the factors promoting the evolution of the institutional systems, in addition to the passive responses of governments to international trade and factors of mobile production factors, there are also active adjustments of the systems made by the governments of various countries. All of these have finally given the country strength in the expansion of its international market share and in the competition over factors of production. Moreover, the deepening of economic globalization directly intensifies the inter-country government competition, and the institutional systems have decisive influences on the cost level of the countries. Thus, institutional system competition has become an important aspect of government competition among countries. Studies and analyses have also been done on the mode of inter-country government competition. Sun Wanyong (2003) holds that the current mode of competition among national governments has shifted from forcebased competition to peace-based competition. For a long time after the establishment of the capitalist system, the government competition between countries was dominated by physical methods, supplemented with peaceful negotiations. This extreme and crude competition mode has brought great destruction to mankind. Painful historical lessons have made governments gradually realize the destructiveness of armed force competition, and thus the competitive mode of peaceful negotiations has begun to be adopted. The establishment and operation of the World Trade

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Organization (WTO) and the World Bank have in particular created platforms for national governments to settle international economic disputes and political disputes, playing extremely important roles in promoting fair competition and peaceful development for all countries in the world. The change in the mode of national government competition has not only boosted the social and economic development of various countries, but it has also effectively improved international political relations. The shift in the mode of national government competition from the worship of military might to the advocate of peaceful negotiation is the inevitable result of the progress of human civilization. The establishment of WTO rules makes the competition among national governments a fair, open, and rule-governed game. In this way, the WTO prohibits governments from the overprotection of their own enterprises, but, instead, has them give all enterprises, domestic or international, equal treatment, or they are subject to legal and economic sanctions. Meanwhile, under the market economy system, the government’s excessive protection of enterprises will strangle their innovative ability, thus playing a negative role in improving the competitive edge of enterprises. In addition, in our modern and civilized society, the practice of robbing the wealth of other countries to realize one’s own economic interests will never be allowed. Adam Smith has even pointed out in his The Theory of Moral Sentiments that although a person is selfish, in a commercial society, his self-interest can only be realized through a “fair and square” agreement with the society. Then, the “agreement” mentioned here is a series of binding clauses such as rules and regulations, international practices, and rules of the game formulated by international organizations. 2.1.2.2 Means of Government Competition After the implementation of fiscal decentralization system in China, the central government has decentralized part of its decision-making power to local governments, giving local governments certain autonomy in economic management and interests. At this time, the local government, as a social service provider in its jurisdiction, must also pay more attention to the interests of their jurisdiction. As a result, the local governments start to compete intensely in various fields and at various levels for the realization of local interests. Although the local government does not have sufficient authority to use monetary policy and exchange rate policy, in reality, the competitive means the local governments can adopt are more diversified than we can imagine. Among them, fiscal policy is the most

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commonly used policy means for local governments to carry out horizontal competition, which can be realized through financial subsidies, tax concessions, interest subsidies, and guaranteed loans. With the continuous improvement and perfection of a market economy system in China, competitive means of providing quality public goods and public services will be more widely used, will gradually replace tax competition dominated by tax incentives, and will become the most important means of fiscal policy. In addition, there are still a variety of competitive methods that local governments can resort to. Compared with the competitive means of the local governments, the ways and means of competition among national governments in various countries are more complicated and diversified, and we will make no detailed analysis here. The following is a further discussion on the means of local government competition. We will, according to its features, summarize and simplify the means into three categories: taxes and subsidies, regulations, and public goods and services. (1) Tax and Subsidy Competition The tax and subsidy competition is the main content of the financial competition among local governments, and is also the focus of studies of the means of government competition. In a narrow sense, the tax competition among local governments refers to attracting the inflow of economic resources by reducing the tax burden of taxpayers, featuring the competition in tax rate and the tax system. Tax competition in a broad sense includes not only tax rate and tax system competition, but also financial subsidy competition (Tang Liping 2007). In China, tax competition is closely related to the financial system, so under different financial systems, tax competition does not assume the same performance. Under the centralized financial system, the central government plans the scale of financial revenue and expenditure in a unified way to realize unified revenue and expenditure. The local governments then have very limited financial autonomy, and their tax competition is mainly represented in two forms: covert tax competition and overt tax competition. The former means that under the uniform regulation of financial allocation of all levels of governments, the local governments capture the government revenue due to other jurisdictions by paying a certain amount of cost. And the latter means that apart from obtaining some financial allocations following the central government’s uniform rules, the local governments also actively lobby the central government for extra

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incomes. However, after the adoption of the reform and opening up policy in the late 1970s in the country, the local governments, under the financial decentralization system, have come to enjoy more financial autonomy. As the transfer payment of the central government is relatively fixed and the local financial crisis is increasingly severe, the local governments, driven by interests, launch competitions, with taxation as the main means, to attract more capital and production factors. From the 1980s to the middle and late 1990s, tax competition became the main means of competition among the local governments in China, subject to the institutional environment, the legal environment, and the economic development pattern at the time (Yin Donghua 2006). Although the local governments did not have independent tax legislative power and the power for levying taxes, the central government also has difficulties in supervision and the problem of high supervision costs due to the information asymmetry between the central government and the local governments. Thus, the local governments could resort to various means, such as tax rate, tax base, tax concessions where they could exercise discretion in levying and administering taxation, to conduct disguised tax competition in their implementation of tax laws and policies (Jin Taijun et al. 2005). These means include not only a large number of formal tax competition methods under institutional norms, but also tax competition tools under the informal system and even outside the formal system. They can be roughly summed up and divided into three categories: tax preferences, tax rebates after levy, and partial tax exemptions. Among them, tax preference is a means local governments often adopt in tax competition. To attract more capital and mobile production factors, the local governments compete to improve the competitiveness of their jurisdictions through tax concessions such as reducing or remitting taxes or the reduction of tax rates. There are not only tax concessions within the system authorized by law, but also tax concessions beyond those authorized by law. Tax rebates after levy is also a way of tax competition among local governments in China. Usually, the local government will return some of the tax revenues collected to specific taxpayers in rewards and other forms. This has gradually become a substitute for tax preferences. In addition, local governments often attract capital inflows by increasing relevant supporting measures and waiving some fees. For example, to support specific investments, the government may use general tax revenues to improve the infrastructure of the projects and even provide land for free. Therefore, it is not hard to see that improvements are still required for local government’s tax competition.

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In the Western countries with federal systems, local governments generally have the right to make adjustments to the tax rate. Therefore, an important competitive means for local governments to attract capital and mobile production factors is tax rate adjustment. On the whole, the means for tax competition in Western countries fall into four types: overall tax burden competition, tax incentives competition, tax type competition, tax exporting competition (He Zengke 2004). Among them, overall tax burden competition refers to the tax competition in which local governments obtain competitive advantages by reducing the overall tax burden of the region’s mobile factors. Tax incentives competition means the tax competition among local governments through specific tax incentives such as tax reduction and exemption for the development of the economy in the jurisdictions. Tax type competition signifies the competition among local governments on a certain category of tax, such as commodity tax and income tax, or competition over a certain tax type, such as personal income tax. Tax exporting competition means a kind of tax competition where the local governments transfer their tax burdens to regions outside their jurisdiction in order to reduce the local tax burden and allow non-local residents or enterprises to bear the effective tax burden. Tax competition will indeed affect the flow of factors of production, and hence affect the fiscal revenue and interest distribution relations of a region or a country. But scholars share different views on what the impact of tax competition can be. In the West, there are two main viewpoints on tax competition: “reducing tax rate” and “enhancing efficiency” (Yang Zhiyong 2005). Some scholars believe that if the government is regarded as a service provider seeking to maximize the welfares of the citizens, it is not necessary to improve the efficiency of the government through tax competition as people’s interests are its first consideration. However, some believe that the government should be treated as a reasonable person who pursues the maximization of its own interests. Therefore, tax competition can serve as a restraint on it and improve the efficiency of its function. Then, in the actual situation of China, what is the impact of tax competition? Is it positive or negative? The answer may lie in whether tax competition is orderly and restrained. If tax competition is benign within a certain range, it may promote local economic development. That is to say, the positive effects of tax competition can only be realized if certain constraints are exercised. When the tax competition exceeds the stipulated binding conditions, it will have a negative impact, which is contrary to the principle of tax fairness, resulting in an increase in taxation costs and enabling

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tax evaders to realize their own interests at the detriment of the economic development of the region. Therefore, in the process of local government competition, the tax competition means adopted must be binding and orderly, so as to ensure the realization of local government competition goals. Regarding the influence of tax competition on local government behaviors, Wu Qiang (2009) has made an analysis and review from three aspects. In the aspect of public goods supply, scholars hold different views on the relationship between the number of competing regions and the level of government public goods supply. Homer Hoyt (1991) has found that with the increase in the number of competing regions, the supply of public goods will monotonically drop. But Toshihiro Ihori and Yang (2008) have discovered, when studying the influence of local government tax competition and regional political competition on the optimal supply of public goods, that the relationship between the number of competing regions and the supply of public goods is not monotonous if taking the political competition into consideration, and that the interaction between local government tax competition and regional government competition may lead to the optimal supply of public goods. Regarding the consistency of tax concessions, the local governments, to attract mobile capital and production factors, will promise certain reduction and exemption of taxes and periods of tax preferences to foreign-funded enterprises. If the government violates the original promise and raises the tax rate when foreign-­ funded enterprises have made investments in local areas and formed part of its fixed assets, there will be the issue of time consistency of tax concessions. Janeba (1995) believes that tax competition will solve the problem of government commitment to a certain extent. If an enterprise invests in multiple countries, although the production capacity will exceed the market demand, the enterprise not only will have compensations for their extra production, but also can deal with the problem of the government’s dishonesty, as the government receiving its investments will reduce its tax rate to a very low level for tax competition. In terms of transfer payments, tax competition has enabled the government to invest too much revenue in economic development and spend less on transfer payments. The comprehensive effects of transfer payment for regional economic development are then inefficient. Moreover, Matsumoto (2008) holds that excessive investment may lead to the exceeding of the total level of public expenditure. Obviously, in the process of helping local governments to realize their interest goals, the means of tax competition will also have an

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important influence on the other behaviors of the government, which is a problem the governments should pay attention to in their practice. Besides, in the studies on financial subsidies, Volkov has used a model to analyze the rationality and effectiveness of government subsidies for enterprises. He finds that in regions with long-term development goals, the local governments usually have higher financial coordination capabilities and generally adopt supportive fiscal policies such as technological transformation and technological research to improve their own competitiveness (Yang Hutao 2006). To keep more and better-run enterprises to stay in their jurisdiction, the local governments often compete with each other in the means of financial subsidies. However, due to certain information asymmetry between the government and enterprises, the enterprises know their own situation better than the government does. And to a certain extent, the government cannot grasp the real and comprehensive information of the enterprises. Therefore, when the government grants financial subsidies, the enterprises and the government enter in a game process. Both parties are committed to maximizing their own interests. All enterprises, whether meeting the requirements or not, will strive for government subsidies. If the government cannot effectively identify the real situation of enterprises, then its dominant strategy will be to provide appropriate subsidies to all enterprises so as to ensure their stay in the jurisdiction. But, in reality, many local governments will subsidize some key enterprises according to their attributes, industry features, and prospects for growth in order to achieve the goal of local economic development. Although preferential government subsidies are inevitable in some cases, Volkov believes that such policies may not be rational strategies considering the uncertainty of the development prospect of the industry and the relocation of enterprises. (2) Institutional Regulation Institutional regulation refers to the government’s management, coordination, and restriction of economic activities in the form of laws and regulations (Tang Liping 2007). Theoretically, it originates from the remedies for market failure (Zhang Jingen 2006). Masu Uekusa, a Japanese scholar, has put institutional regulations into two categories: indirect regulation and direct regulation. Indirect regulation means the restriction of unfair practices such as monopoly by formulating and improving relevant laws and regulations. Direct regulation can

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be subdivided into social regulation and economic regulation. Social regulation mainly refers to environmental, health, and safety regulations, targeting not specifically to certain enterprises, but requires any enterprise in any industry to comply with the relevant national laws and regulations on pollution control, product quality, and workplace health and safety. Economic regulation is aimed at a series of special industries such as monopoly industries, public service sectors, and industries concerning national security. Traditionally, economic regulations may cover industries for public utilities, transportation, and finance, while the implementation of regulation mainly involves the control of prices, entry, and service quality of the mentioned industries. The content of economic regulation can be summarized in four aspects: first, price regulation. That is, through the regulator’s direct guidance on market pricing, the price of industrial products and services will be guided by the price range of the ceiling price and the floor price and flexibly arrange the window period for price guidance according to the specific situation. Secondly, market entry and exit regulation. In order to realize the scale economy of an industry, the government regulators will restrict new entrants to the industry and raise barriers to industrial entry. At the same time, for the stability of supply, the government regulators will also impose corresponding restrictions on the exit of enterprises industries. Thirdly, investment regulation. Investment regulation has two meanings: firstly, it refers to the local government’s introduction of investment policies to directly interfere with the investment decisions of enterprises; secondly, it means to take the leading power of investment decision-making from a macro level, prudently supervise investment projects to avoid redundant investments, and promote the realization of higher-level economic development goals. Fourthly, quality control. As the quality of the products and services of many industries are difficult to observe or measure, so in some regulated industries, the government regulators often link quality with price, instead of carrying out quality regulation alone. Obviously, among all the regulatory means, price regulation and market regulation are the most practical and feasible, so they are regarded as common regulatory tools. In real economic activities, government regulations often play an extremely important role in the choice of factor owners, producers, and consumers. Therefore, the act of government regulation will generally affect the behaviors, constraints, risks, and benefits of the agents of microeconomic activities (Lin Shangli 1998). Under different regulatory conditions, the microeconomic agents can adopt “foot voting” to select regions

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with lower regulatory costs for the realization of their own interests. Meanwhile, this will also affect local economic growth. Then, in the process of local government competition, regulation competition also has the feasibility in theory and practice as it is a powerful tool for local governments in competition. As a manifestation of institutional competition, institutional regulation competition has also attracted the attention of the different schools of economics. In the studies of economic growth, the traditional school of economics will consider institutional factors as exogenous variables, believing that the system will not change and has nothing to do with economic growth. It mainly explains the problem of economic growth through changes in various factors of production, excluding the institutional factors. But facts have proven that when factors of production undergo no changes, the economy also shows a growth effect. Thus, institutional economists improve the research variables of the traditional economics school, take the institution as an endogenous variable of economic growth, make analysis of the important role of institutional changes and innovations in economic growth, and prove with their research results that economic growth depends on institutional arrangements. The efficiency of economic organizations will determine the efficiency of economic growth endogenously. If the efficiency of economic organizations is low, even if there is nominal economic growth, the cost behind it may be higher than its benefits. Then, to ensure the efficiency of an economic organization, reasonable institutional arrangements must be made to encourage individuals to turn their economic efforts into activities with similar personal and social rates of return. It is obvious that efficient economic organizations and system innovation are the basic driving forces for a country or region to realize its economic development. The variations in institutional arrangements and institutional changes will lead to different performances of economic activities, that is, a country’s system will play a decisive role in the results of economic activities. Moreover, in the studies of industrial competition, the institutional environment should also be taken into consideration, and the industrial issues of a country or region should be solved in the whole system arrangement and structure, because the institutional changes in a country or region will determine the changes in its industrial structure, and the institutional changes are closely related to the intensity of regulation competition. Starting from this point, the optimization of industrial structure in a country or region is the result of institutional competition, not simply the result of economic growth. In institutional

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competition, the government is the primary action group of institutional innovation, that is, the government plays an irreplaceable role in the process of institutional change and institutional innovation. At the same time, the system is the source of the government’s sustained competitiveness, and institutional innovation is an important variable that affects the government’s competitiveness. Whether the institutional resources are rich or not is crucial for the government to improve its competitiveness and realize its primary economic goal. Then, when the original system loses its incentive function, the government should actively carry out system innovation. As a manifestation of institutional competition, government regulations must also have an important influence on the realization of government goals. In China, the institutional regulation competition among local governments is integrated not only with the formal systems, but also through the informal constraints, which together strengthen the competition landscape. The local governments have implemented different regulations on the inflow and outflow of capital and production factors, and, at the same time, there are the direct and indirect regulation competitions. The regulation competition among local governments in China is largely manifested as local protectionism. To realize the economic interests of the jurisdiction and to restrict the inflow and outflow of the important resources, the local governments will exercise such regulations as “issuing government confidential documents,” “issuing office minutes,” “ setting up road checkpoints,” “render manipulation,” technical barriers and rate control to prevent the outflow of local resources and impose restrictions on the inflow of outside resources. Since October 1980, the central government of China has issued several regulations prohibiting local protectionism. However, as the regulations do not have sufficient authority relative to the law, they have not been well implemented. Moreover, The Law of People’s Republic of China Against Unfair Competition has its blind spots in practice under the current legal environment: if the competition behaviors of the local governments exceed the legal scope, they will only receive criticism from the government at a higher level and will not receive administrative prosecution (Wang Xiaoye 1999). The Regulations of the State Council on Prohibiting Regional Blockade in Market Economic Activities promulgated in 2001 only strengthens the punishment measures, but this blind spot has not been completely eliminated in the system (Feng Xingyuan 2001). Statistics show the inter-provincial trade ratio in China has experienced a downward turn in the 1980s. From 1978 to

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1989, the proportion of inter-provincial consumer goods import has dropped from 38% to 36%, and the proportion of inter-provincial consumer goods export has declined from 47% to 38%. In addition, a World Bank report shows that in 1985 and 1992, the average annual growth rate of China’s total foreign trade import and export was 10% and 17%, respectively, while the average annual growth rate of domestic inter-provincial trade was only 4.8%, far lower than the growth rate of foreign trade. The main reason is that the practices of local protectionism in provinces have built up trade barriers and hinder the freedom of trade (Yang Xuedong et al. 2006). By the mid to late 1990s, with the boost of investment and capital introduction throughout the country, institutional competition has become a key area of local competition. The specific tool for competition has been “weakened regulations,” that is, to attract investments with loose institutional constraints. (3) Public Goods and Services Competition Public goods and services competition is also one of the means of competition among local governments. Since the level and quality of public goods and services represent the image of a local government, this means of competition is also an effective way to improve the government’s ability to attract outside resources. Therefore, for better development of the local economy, the local governments will compete for the supply of public goods and services. The competition covers various aspects of infrastructure construction, such as water and electricity supplies, the improvement of traffic conditions. It also includes strengthening the publicity of regional images and various administrative services provided by local governments. Compared with financial policy competition, in the competition of public goods and services, the local governments will not leave financial funds with enterprises but invest them in public facilities construction and public services. This may not directly affect the profit rate or factor return rate of the enterprises, but many productive infrastructure constructions can enter the enterprise production function as input factors, constituting on the whole an important foundation for the survival and growth of enterprises. When studying the supply of public goods and services, many scholars have shown concerns about government competition. Among the issues in discussion, the impact of residents’ mobility on the local government’s financial expenditures has also aroused academic interest. As consumers of local public goods and sources of local fiscal revenue, the residents in a

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jurisdiction have potential mobility. And this mobility will inevitably lead to the flow of capital and factors of production, thus making the move an endogenous variable of local government’s public expenditure. Accordingly, all local governments, taking into account the impact of residents’ mobility, hope to improve the efficiency of resource allocation through the provision of public goods and services on the whole. Charles Tiebout, a US economist, has proposed in his paper “A Pure Theory of Local Expenditures” the “foot voting” theory where he reveals that the local government, for the competitiveness of its jurisdiction and the attraction of the region to its residents, must provide the best combination of public goods and tax burden (Tiebout 1956). The rational residents will compare the levels of public services and tax burden in different regions to make effective choices to maximize their own utility. Then, the residents may show their preference for the combination of public goods and tax levels through “foot voting,” thus effectively enhancing the optimal allocation of public resources. When the residents who choose the same residential area have the same level of income and similar preferences, they do not need to vote to determine the supply of public goods and services. It is then self-evident that under the restriction of residents’ mobility, the local governments will have the motives to provide better public goods and services. The school of institutional economics, when studying the supply of public goods and services, takes the perspective of the government’s own functions, holding that the central government and the local governments should follow as much as possible “the principles of subsidiarity” in financial allocation and the supply of public goods by implementing the fiscal decentralization system. That is, the school advocates placing each task in the government’s actions in the lowest possible level of government agencies to resolve the government’s tasks and enable each local government to undertake different tasks through competition. Therefore, when designing a general financial system, the central government should try its best not to make any vertical public financial transfer, but instead have each local government raise its own funds through taxation, charging fees, to accomplish its mission. Adam Smith has also pointed out in his An Inquiry into the Nature and Causes of the Wealth of Nations that local governments are the most efficient functional arrangements for providing local public goods and services. If the services a public project can provide are limited to a specific region or place and cannot be maintained with its own profits, it is better to hand it over to the local government for

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management than to manage the project by the central government. For example, if the expenses for street lamps and paving roads in London are maintained by the central treasury, then the street lighting lamps are hardly as perfect as they are now. And the cost will not be saved either. Moreover, if the expenditure on this public project is provided from the general income of the country instead of the local taxes provided by residents of specific neighborhoods or specific urban areas in London, then the other residents in the country who cannot enjoy the services must also share the tax burden for this purpose, which is obviously unfair. Joseph Stiglitz, the founder of information economics, believes that the provision of public goods and services by local governments can not only lay the foundation for competition among local governments, but gain the potential benefits emphasized by Charles Tiebout. Fiscal decentralization can promote competition among local governments and maximize the residents’ own utility, accompanied by the increase of mobile capital and factors of production (Stiglitz 1998). Thus, we can see the competition among local governments, like the competition among enterprises, also plays the same role of ensuring the effective supply of public goods and services and making the quantity and types of public goods more in line with public demand. Moreover, the excellence of regional investment environment determines the speed of local economic development to a great extent. From the perspective of game theory, if the local government wants to make the region more appealing to foreign investment, it must not only reduce the tax burden in its jurisdiction but also try its best to improve the investment environment in the region, providing more comprehensive infrastructure to reflect the advantages of local governments in the whole game process. In China, the competition between local governments regarding public goods and services lies in two aspects: infrastructure construction and institutional public goods. In the following, we will discuss further the specific forms of competition in the two aspects. In the competition of infrastructure construction, local governments attach great importance to the infrastructure construction in their jurisdiction to improve the local investment environment and solve the problem of backward infrastructure brought about by lagging urbanization, which is clearly reflected in the investment strength. In recent years, the scale of public investment of local governments in China is clearly larger than that of Western countries. And the growth of investment in this aspect is also very significant. These investments are mainly used for infrastructure

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projects involving energy, roads, communications, and related real estate, and are led and promoted by local governments (Zhang Leibao 2005; Yang Hutao 2006). In addition, the competition in staging exhibitions, as an extension of infrastructure construction competition, is also in full swing among local governments in the country. Through the publicity in the form of exhibitions, the image and reputation of a region can be quickly and effectively spread for attracting a large number of mobile production factors. Therefore, starting from the late 1990s, the upsurge of new construction, renovation, and expansion of exhibition venues continues to this day. In institutional public goods competition, sound institutional supply will play a crucial role in improving the competitiveness of local governments and the economic growth of the jurisdiction. In the local government competition, each local government has its own comparative advantages and disadvantages, but there is a comparative advantage that can make up for all the comparative disadvantages, and there is also a comparative disadvantage that will wipe out all comparative advantages. This is institutional innovation. Wolfgang Kasper and Manfred E. Streit (2002) have pointed out that institutional competition will mobilize creativity in various fields such as technology, organization, and economy. It helps to improve the political administration and judicature of government agencies, thus accelerating the growth of productivity and improving the government’s own competitiveness. Therefore, in the process of government competition, some local governments have gradually realized the importance of institutional public goods competition and the difficulty to maintain the competitive advantages simply by relying on preferential policies. The reform of administrative examination and approval procedures proposed by the local government is a full reflection of the efforts made by the local government in institutional competition. Meanwhile, driven by the local government, the reform of China’s property right system has also gradually made progress. Of course, at present, the institutional public goods competition between local governments in the country still stays at a lower level and much remains to be improved. 2.1.2.3 Measurement of Government Competitiveness Government competition is an interactive game between different levels of governments or between governments at the same level. The description of a government’s competence for such games constitutes a measure of the government’s competitiveness. There is no uniform conclusion in

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academic literature as to the definition of government competitiveness. Scholars from the International Institute for Management Development (IMD), Switzerland, in their discussion on the theoretical basis of international competitiveness evaluation, have given the definition of international competitiveness from a commercial point of view, stating that international competitiveness is how a nation creates and maintains an environment that enables enterprises to maintain their competitiveness, and how the policies implemented by the nation form an environment in which enterprises are competitive. To a certain extent, this definition is more appropriate for the definition of government competitiveness. The World Economic Forum (WEF) and the Organization for Economic Cooperation and Development (OECD) have also given their definitions of government competitiveness from the perspective of national competitiveness. The WEF holds that national competitiveness is a country’s ability to maintain a high rate of per capita GDP growth. The OECD defines that a country’s competitiveness refers to the level a country can reach in providing products and services needed in the international market under the condition of maintaining free trade, fair market, and long-term stable growth of its people’s actual income. Wang Zuocheng (2007) maintains that the so-called government competitiveness is a comprehensive force a government demonstrates in the competition between two or more countries or regions, which integrates disparity, comparative advantages, attraction, and profitability. We believe that government competitiveness refers to the comprehensive quality or capacity of a country or region’s government to achieve its own sustainable development, which is reflected in its competition with other governments. Then, to further analyze the government’s competitiveness, scholars measure it by constructing evaluation index systems. The following is an analysis about the routine indicators in the existing literature and the innovative indicators established in this part, respectively. (1) Routine Indicators WEF and IMD are the authoritative international organizations in measuring the government’s competitiveness. Since 1996, WEF and IMD have been publishing international competitiveness yearbooks. Their evaluation systems include the government competitiveness subsystems. Though the government competitiveness evaluation indexes they choose vary from year to year, the final conclusion is relatively uniform. Given the

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intense government competition, the openness of the market, the integrity of the government, the rationality of the tax rate, the mobility and improvement of the labor market, the independence of the judicial system, and the level of construction of regional public facilities will all promote the local governments to further consolidate their own competitive advantages. In China, some scholars have also set up competitiveness evaluation index systems suitable for local governments from various perspectives. Li Yang, a Chinese scholar with the Chinese Academy of Social Sciences, has even used the case study method to conduct empirical studies on the cities of Gujiao in Shanxi, Zhangjiagang in Jiangsu, and Tongxiang in Zhejiang (Li Yang 2001). Yan Dawei (2006) first analyzed the duties of the local governments and holds that the main duty of the local governments in China is to provide public goods and services for residents and enterprises in their jurisdiction on the basis of tax revenues. It has also suggested that the competitiveness of local governments should be evaluated starting with the production efficiency and efficiency of public goods. Liu Chao and Hu Wei (2007) first define the competitiveness of local governments and believe that the local government’s competitiveness should be measured from the three aspects of technology, system, and public goods supply. Ren Weide (2005), based on the analysis of the basic substance of local government’s competition in China, has pointed out that the competitive power of local governments in China should be measured from the aspects of system, technology, provision of public goods, and the administrative efficiency of the government. A review of the relevant domestic and foreign literature on the local government competition and the local government competitiveness will readily reveal domestic and foreign scholars have carried out theoretical studies on competition modes, manifestations, and effects. Some scholars have chosen the respective evaluation indexes from the connotation of local government’s competitiveness and the mechanism of local government’s competition, but so far no systematic studies on the issue have been conducted. We endeavor to establish a competitiveness evaluation index system applicable to the local governments at the provincial level in the country in this part, and believe that this evaluation system can be used as an alternative institutional arrangement for the existing yardstick competition1 evaluation system to optimize the government competition order and improve the quality of economic operation. 1

 For detailed discussions of yardstick competition. See Chap. 5.

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(2) Innovative Indicators The concept of local government competition is constantly in dispute. The more authoritative definition has been given by Stiglitz. We will also adopt the definition of Stiglitz, holding that the competition between local governments is centered on the system, technology, public goods, and service supply, and the main purpose is to attract more mobile factors of production. Chinese scholars, combining the definition by Stiglitz, believe that the competitiveness of local governments in China should be measured in four aspects: system, technology, public goods supply, and government administrative efficiency. We will also select the factor analysis and follow that the local government competition in China is mainly carried out in four aspects: system, technology, public goods supply, and government administrative efficiency, and select these four indicators as the primary indicators. On this basis, the corresponding secondary indicators are constructed, and the evaluation index system of government competitiveness applicable to the local governments at the provincial level in China is established. See Table 2.1. Table 2.1  Evaluation index system of local government competitiveness in China

Competitiveness of local governments

Primary indicators

Secondary indicators

Efficiency of system innovation

Number of national development zones Reduction of government intervention in enterprises Reduction of the extra tax burden on enterprises Strength of introducing foreign capital Legal system environment The proportion of R&D expenditure in GDP Proportion of science and technology appropriation in local financial expenditure Coefficient of national science and technology achievement award Patent holders per 10,000 Intellectual property protection Per capita financial income Per capita expenditure of social undertakings such as science, education, culture, and health Per capital expenditure of general public services The share of administrative charges in fiscal revenue Proportion of administrative expenses to financial expenditures Reduction of the scale of government

Efficiency of technological innovation

Efficiency of public goods supply Efficiency of government administration

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Douglass North holds that a system is a series of formulated rules. The system provides a framework for human interaction and establishes a cooperative and competitive relationship of economic order. The history of economic development has shown that the system has become an important factor restricting economic development. Therefore, system competition is the main mode of competition between local governments at the provincial level in China. It is mainly manifested in tax competition, subsidy competition, and regulation competition. Although fiscal decentralization reform has been in implementation since 1994, local governments have not yet made their own decisions on tax rates and tax bases. The development zones, bonded areas, and tax concession policies can play a disguised role in reducing tax burden and attracting foreign investment. Therefore, we will choose in this part the number of national economic development zones and the secondary indicators such as the government’s reduction of enterprise tax burden and extra tax burden, the strength for attracting FDI, and the legal system environment to measure the competitiveness of local government’s system innovation. Among them, the last four indicators come from NERI Index of Marketization of China’s Provinces 2011 Report by Fan Gang and Wang Xiaolu. Scientific and technological innovations have become important factors affecting economic growth. Therefore, local governments at all levels have increased their investments in science and technology to boost the economic development of the jurisdiction. The technology competition of local governments is mainly reflected in increasing expenditure on scientific researches and strengthening the protection of intellectual property rights. In this part, the proportion of research and development (R&D) expenditure in GDP, the proportion of science and technology appropriation in the local financial expenditure, the coefficient of national science and technology achievement award, the number of patent holders for every 10,000 people, and intellectual property protection are selected to measure the technological competitiveness of local governments. Among them, the index of intellectual property protection comes from NERI Index of Marketization of China’s Provinces 2011 Report by Fan Gang and Wang Xiaolu. As one of the most essential factors of local government competition, public goods supply plays an important role in measuring the competitiveness of local governments. We have selected the three indicators of per capita fiscal revenue, the per capita expenditure on social undertakings such as science, education, culture, and health, and the general public service per capita expenditure for the measurement.

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Competition in institutional innovation and technological innovation must be supported by a clean and effective government. The efficiency competition between local governments is mainly manifested in open government affairs and the establishment of an open, efficient, low-input, and high-output government. Therefore, we have selected the three indicators of the proportion of administrative charges in fiscal revenue, the proportion of administrative expenses in fiscal expenditure, and the strength to reduce the size of the government for measuring the administrative efficiency of local governments in this part.

2.2   M&A and Its Corporate Consolidation Effects In the past 50 years or so, M&A and corporate consolidation have been a research field of utmost concern for economists and policy-makers, and abundant results have been achieved. We will in this part summarize the perspectives of studies on M&A and corporate consolidation, respectively. 2.2.1   Value Creation and Impact Factors of M&A M&A has always been a topic of great interest in applied economics. The corresponding M&A theory and empirical studies are also classic issues in the studies on corporate finance and enterprise investment and financing. From the aspects of M&A integration and performance, the relevant explorations can be divided into two categories. The first category is to use various methods to study whether M&A can create value for a company and the second focuses on the factors affecting the performance of M&A. 2.2.1.1 Studies on Value Creation of M&A Two major systems have been formed following the different approaches to the value creation of M&A: one is the approach of event studies, and the other is the accounting study method. (1) The Event Studies Method Scholars outside China pay more attention to the issue of “whether M&A can bring benefits to shareholders.” In their studies, event studies methods are often used to establish econometric models for empirical

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studies. Different samples or studies of different periods have led to diverse conclusions. For example, Agrawal and Jaffe and Mandekle (1992) have provided studies on the samples of M&A between 1955 and 1987. They have found that the cumulative excess return of the target company after the merger is negative, but studies of many other scholars show M&A can bring positive excess return. Dodd and Ruback (1977) have found through the study of the tender offers from 1973 to 1976 that shareholders of the acquiring company have generally obtained 8%–12% of the excess earnings, while shareholders of the target company have obtained 19%–21% of the excess earnings. Dodd (1980) has also found that the shareholders of the target company have obtained 13% of the excess return, while the excess returns for the shareholders of the acquiring company are negative. Jensen and Ruback (1983), based on previous studies, hold that successful M&A will bring about 30% of the excess return to the shareholders of the target company, while the excess return obtained by the shareholders of the acquiring company is relatively small. Thus, the study results of scholars using the event studies method vary with different samples and different time spans. With the increase of M&A samples in China, Chinese scholars have also conducted studies using the event studies method. Chen Xinyuan and Zhang Tianyu (1997) have taken the exchanges at Shanghai and Shenzhen stock markets in the 31 trading days before and after the announcement of the M&A in 1997 as the event window to conduct their event study. The study shows that the accumulated excess return of the merging company shows an upward trend before and after the announcement. Yu Guang and Yang Rong (2000) took the M&A in the Shanghai and Shenzhen stock markets from 1993 to 1995 as research samples and made calculations of the excess returns of ten days, five days, and one day before and after their announcements at the stock markets, respectively. It was found that the shareholders of the target company can obtain positive excess earnings while the earnings of the merging company are not obvious. Li Shanmin and Zhu Tao (2005a, b) have provided a long-term event study on 1672  M&A cases in Shanghai and Shenzhen stock markets in China. Their results show that most of the acquiring companies will face negative value impact for several years after the acquisition is completed. The studies by Chinese scholars using the event studies method have not reached a more consistent conclusion.

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(2) Accounting Study Method The accounting study method is to select certain financial indicators to measure the operating performance of the M&A and to observe whether the deal can create value for the company after removing other impact factors. Few studies have been carried out by foreign scholars using the accounting study method. Healy (1992) selected 50 M&A transactions to compare with those companies in the same industry without M&A transactions. The results show the operating capacity of the acquiring company have been significantly improved after the deal, that is, the transaction can create value for the company. Parrino and Harris (1999) reached the same conclusion in their studies. But there have been opposite conclusions. For example, the study by Ghosh (2001) shows that M&A has no significant impact on the performance of the acquiring company. Many Chinese scholars have explored the performance of M&A of Chinese enterprises based on accounting data. Feng Genfu and Wu Linjiang (2001) selected ten financial performance indicators to conduct an empirical study of 201 M&A cases in China from 1994 to 1998. They found that the M&A performance shows a first-rise-then-decline trend, and that the performance was influenced by the type and timing of the transactions. Li Shanmin et al. (2004) have conducted a principal component analysis (PCA) on the cases of M&A that took place in 1997–1999, but no unanimous conclusion was reached. Zhang Xin (2003) has conducted an analysis using the event study and accounting study methods and has explored whether M&A have created values. It concludes that the M&A deals have created values for the target company but have negative influences on the acquiring companies. And on this basis, Zhang has proposed the M&A motivation theory of “obtaining value transfer and redistribution under system factors.” Xing Tiancai and He Yinxuan (2011) have taken 319 cases of M&A from 2004 to 2007 as research samples, and used the accounting study method to investigate the long-term M&A performance of the acquiring company. The result fails to support that the long-term performance brought about M&A deals. Thus, the studies in China with the accounting method have also not reached a consistent conclusion.

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2.2.1.2 Studies on the Impact Factors of M&A Performance While studying whether M&A can create value, scholars have also carried out theoretical analysis and empirical studies on the factors affecting the performance of M&A to varying degrees. At present, the well-recognized influencing factors have been industrial effects and the M&A transaction features. (1) The Impact of Industrial Effects on the Performance of M&A Richard Schmalensee (1978) was the first to study the impact of industrial effects on company performance. He found through the study of 456 listed companies in 242 industries that the industrial effects account for 20% of the company’s performance influencing factors. Based on the finding, many scholars have incorporated industrial effects into the analysis of M&A performance. The study by Li Qiong and You Chun (2008) shows that industrial effects have the greatest impact on the performance of conglomerate mergers. The research results of the industrial effects on the performance of M&A are still relatively consistent. It is generally believed that the industrial effects have obvious influences on the performance of M&A. (2) The Influence of M&A Transaction Features on M&A Performance Scholars have also analyzed the impact of the M&A transaction features on the performance of M&A from the aspects of terms of payment and types of M&A.  Singh and Montgomery (1987) have also shown that when the M&A take place in the same industry, the returns for the shareholders of M&A companies are obviously higher than when the deals take place between enterprises in different industries. Gordon and Yagil (1981) have found that the terms of payment also have an obvious influence on the performance of M&A. Cash payment can bring about higher excess returns. (3) The Influence of the Property Rights System on M&A Performance Many scholars show concern for the impact of SOE restructuring on enterprise performance from the perspective of property rights system reform in the economic transition period (Zhang Weiying 1998; Song Ligang and Yao Yang 2005a, b), and have analyzed the system

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motivation for the M&A of SOEs. On this basis, the performance of M&A is analyzed using market indicators or financial indicators (Pan Hongbo et al. 2008; Fang Junxiong 2008). The studies above are basically carried out around the issues of ownership and property rights, that is, from the perspective of “restructuring” of SOEs through M&A, taking the M&A of state-­owned listed companies as “second restructuring,” and regarding them as the result and embodiment of path dependence in institutional changes. 2.2.2  Corporate Consolidation and Its Impact Mechanism 2.2.2.1 An Interpretation of the Basic Theory of Corporate Consolidation Corporate consolidation is a high-level form of resource allocation. It has been interpreted from the micro (enterprise) level and the meso (industry) level, respectively, in the transaction cost theory and the overproduction theory. In the 1930s, Ronald Harry Coase, a celebrated American economist, put forward the “transaction cost” theory. He believes that transaction cost is the cost needed to obtain accurate market information as well as the cost of negotiations and recurrent contracts. On the question of why enterprises exist, his conclusion is that by forming organizations like enterprises, some costs of outsourcing to the market can be reduced. Similarly, the factors of production allocated by enterprises also correspond to transaction costs in the form of administrative costs and management costs; therefore, transaction costs will endogenously promote the integrated and centralized development of enterprises in the industry, thus creating the internal demand for corporate consolidation. That is to say, enterprises use the synergistic effects and scale effects of corporate consolidation to reduce transaction costs through continuous M&A, to gain greater advantages, leading to the continuous expanding of the scale of enterprises, thus making enterprises more inclined to resort to M&A for corporate consolidation. Michael Jensen, a famed professor with Harvard Business School, has proposed the theory of “overproduction.” He has analyzed corporate consolidation from the perspective of changes in industrial structure and believes that in the emerging stage of an industry, the high rate of return of the industry will attract a large amount of capital to enter and push forward the expansion of the industry. As the industry grows to maturity,

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there will be excess production capacity in the industry. The high profits disappear, and the enterprises with low competitiveness in the industry will be forced to quit. However, because of the existence of exit barriers, it is not easy to quit. And at this time, M&A will become a more appropriate mode of exit. In this way, corporate consolidation is realized. Under this theory, corporate consolidation occurs more often in the maturity industries and sunset industries. 2.2.2.2 Different Perspectives for the Analysis of M&A and Corporate Consolidation (1) M&A and Corporate Consolidation from the Perspective of Industrial Cycle Theory The economic theories related to the life cycle are mostly developed at the level of products or industries. The industrial life cycle theory has also evolved from the product life cycle theory. The Gort-Klepper (G-K) theory is the basis of the industrial life cycle theory, which starts with the analysis of time series and uses the net growth of manufacturers in the industry as the main standard to establish the first life cycle model in industrial economics. On the basis of G-K theory, Steven Klepper and Agarwal have developed the model in terms of competitive cost and stage duration, respectively. Klepper (1990) has established a free competition model of the stochastic process model, emphasizing the cost competition effect of process innovation. Agrawal et al. (1992) has introduced the break-­even operating ratio. By analyzing the changes in the break-even ratio of enterprises entering the industry at different stages, it deals with the impact mechanism of businesses entering and exiting the industry. In addition, Klepper (1996) has put forward the oligarch theory of evolution of technical efficiency survival based on survival and distribution analysis. It has emphasized that market endogeneity of technology is one of the characteristics of this theory. Through the analysis of business survival and distribution, the research object is locked into the formation of an oligopolistic market, and the research on market structure with concentration as the main method gets expanded to more detailed studies on entry rate, exit rate, and business distribution, providing a new perspective for empirical industrial organization (EIO) studies. Through the analysis of the evolution of the industrial life cycle, it is not difficult to find this theory is developed around the number of companies

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in the industry or the entry and exit mechanism of companies. However, whether it is the discussion of innovation, distribution of enterprises, or market structure, the theories are all based on the efficiency or profitability of the individual company. The M&A motivation and performance of enterprises in different industrial life cycles are different. Anand and Singh (1997) have conducted studies on the M&A of US national defense industry in the decline stage and have found that horizontal M&A are superior to other types of M&A in the industry. This is the earliest study that combines the industrial life cycle with the types of M&A. Maksimovic and Phillips (2008) have found that diversified enterprises in the growth industries have improved their operating efficiency after acquisitions. The reason is that the internal capital markets of diversified enterprises have eased the financial depression of the industrial sector. Huang Juan and Li Qingyuan (2007) have studied the impact of the industrial life cycle and M&A types on the company’s operating performance. The study has found that companies in the growth industries have the best performance in the vertical M&A and conglomerate merger. The study takes the financial indicators as the basis and uses the life cycle evaluation theory. (2) M&A and Corporate Consolidation from the Perspective of Regional Economy From the perspective of regional economy, corporate consolidation embodies the spatial cluster of enterprises, that is, industrial cluster, which is basically defined based on the two aspects of geography and industry. The early studies of industrial agglomeration pay more attention to the correlation of industries and ignore their geographical characteristics. Joseph Alois Schumpeter has proposed the concept of an “Innovation Cluster.” Schumpeter believes that there are economic cycles or economic fluctuations. In addition to external factors such as war and climate, innovation is also an important factor causing economic fluctuations. Meanwhile, he thinks that innovation has cluster effects. The process of enterprises realizing profits through innovation will be imitated by other enterprises. This imitation has the centralization of economic sectors. Since Schumpeter’s definition of cluster was put forth on the background of economic fluctuation, it is more related to the correlation between industries without considering other geographical characteristics, and

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therefore different from the definition of industrial cluster mentioned by later scholars. With the development of corporate consolidation, the phenomenon of industrial cluster is getting more and more obvious. It is highly centralized geographically, and geographical features gradually become one of the fundamental characteristics of the concept of industrial cluster. Michael Porter, another master of management, has paid more attention to the geographical features in an industrial cluster, believing that an industrial cluster is the geographical agglomeration of related enterprises in a specific field. The geographical features of industrial cluster are gradually recognized and an industrial cluster is considered to be a phenomenon where a large number of enterprises in the same industry are located in the same geographical area. In addition to geographical characteristics, an industrial cluster can also be reflected in industrial characteristics. The industrial characteristics are the nature that reflects the relationship between different enterprises within the industry and different elements within the industry. They are not unified, so there will be some differences in the description of industrial characteristics. From the perspective of the industrial chain, Michael Porter believes that an industrial cluster includes a series of clusters of related industries such as the clusters of suppliers, manufacturers, and retailers. That is to say, an industrial cluster can be extended to suppliers of raw materials at the upstream and to distributors of products at the downstream. Horizontally, it can be a cluster of enterprises of the same industry or related industries. Redman has defined an industrial cluster as a geographic agglomeration of related industrial chains, which include basic service institutions (educational institutions, infrastructure, etc.) that can improve industrial competitiveness. Extending the meaning of industrial cluster to basic service organizations reflects the important role of basic service organizations in an industrial cluster. Hill and Brennan define a competitive cluster as the geographical concentration of enterprises in the same industry or of different industries that can carry out frequent trading. They use the same technology or sharing infrastructure with each other, which can reduce their production costs and bring the enterprises a competitive edge. Chinese scholars have made explorations on industrial clusters, emphasizing the geographical characteristics of an industrial cluster and the scale synergy effect brought by the practice. Wang Jici (2001) has pointed out that a cluster is a phenomenon of spatial agglomeration of enterprises in

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the same industry or related industries. It depends not only on the historical tradition of the region, but also on the competition and cooperation among enterprises in the region. In addition, clusters not only take place among different enterprises. They also play a key role in government, universities, and relevant vocational training institutions, which can provide specialized training, education, and technical support to enterprises to promote the development of the industry. To sum up, the industrial cluster defined in this part has geographical and industrial characteristics, and refers to the spatial agglomeration of all member enterprises and member elements (including cluster agencies and public service agencies) related to the industry. Through cluster and gathering and sharing resources, different enterprises can reduce costs and enhance their competitive advantages in the industry.

2.3   M&A and Corporate Consolidation from the Perspective of Government Competition: A New Analysis Framework Previous studies on M&A and corporate consolidation are mostly based on the theoretical framework of mainstream economics and follow the perfect market hypothesis. In the empirical studies, the analysis of M&A effects is mostly limited to the micro level. The M&A studies from the perspective of industrial market structure mostly take industrial and market structure as exogenous variables to analyze their impacts on the behavior and occasion of M&A. There are few Chinese and foreign literatures on corporate M&A and the evolution of industrial market structure from the perspective of government competition. But the government is an important player in economic development in the course of economic transition. Therefore, from the perspective of government competition, we propose a new framework for the study of M&A and corporate consolidation (see Fig. 2.1). This book starts with the essential issues of M&A in China during the transitional period, focuses on “the existence of the wave of M&A-the mechanism of M&A under government competition—the process of corporate consolidation under government competition—the micro- and macro-performances of M&A,” and explores the mechanisms and effects of M&A on the evolution of industrial economic structure and regional economic structure under the government competition paradigm. Emphasis will be laid on the following issues.

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Fig. 2.1  M&A and corporate consolidation from the perspective of government competition: a new analysis framework

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2.3.1  The Existence of M&A Wave in China: A Survey Based on Government Behaviors Based on the relevant working definitions, this book will expound the existence of the M&A wave from the theoretical logic approach and the historical experience approach, carry out empirical test on its macro motivation, and explore the internal relationship between government behavior and the wave of M&A.  On this basis, from the perspective of local government behavior, the book will undertake theoretical and empirical analysis of typical phenomena such as privatization of local SOEs, the connectivity of local SOEs with the central SOEs, and the RTOs. This is an overall description of the macro motivation of M&A, laying a foundation for the explorations that follow. 2.3.2  Occurrence of M&A: Theoretical Model and Empirical Analysis Firstly, based on the Cournot model, we will use the cooperative game method to establish the M&A model incorporating government behavior. After this, we will further build an endogenous M&A model of state-­ owned enterprises participating in  local government competition, and explain the operating mechanism of the local government’s behavior on the M&A of SOEs in its jurisdiction. Secondly, we will construct a model of exogenous M&A under the local government competition paradigm from the perspective of tax competition, expenditure competition, and regulation competition, respectively, use the empirical measurement to quantitatively identify, and test the factors that affect the occurrence of M&A, focusing on the mechanism of government behavior affecting the occurrence of M&A. 2.3.3  M&A and Corporate Consolidation Mechanism Under Local Government Competition, the Key Section of the Book The local government competition, driven by financial and political incentives, is mainly centered on gathering resources and has two dimensions. In the dimension of regional economy, we will, firstly, generally examine the relationship between government competition and regional industrial structure based on the extended yardstick competition model, explain the impact mechanism of government competition on regional specialization,

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then examine the industrial path of SOE M&A, its market structure effects and industrial structure effects, and take manufacturing industry as an example to empirically study the relationship between M&A and the industrial cluster. In the dimension of industrial economy, we will start with the measurement of M&A performance, introduce the government behavior and its related institutional factors, and based on an investigation of the micro performance of M&A, treat the problem of industrial cluster as an endogenous phenomenon, and study the government’s competitive conducts and the macro performance of intra-industry M&A. In the light of life cycle theory, the book will analyze the relationship between government intervention and M&A performance from the perspective of enterprise cycle and industry cycle, respectively, stressing the macro performance of conglomerate mergers under the framework of government competition, that is, its relationship with the optimization and upgrading of industrial structure. The book will also carry out an empirical analysis, taking emerging industries of strategic importance as an example. In the real economy, the regional industrial structure is closely related to the regional layout of an industry. They determine that the analysis of the two dimensions is related to each other and echoes each other. If, from the perspective of regional economy, the relationship between M&A and industrial cluster are examined on the “strip” (industry) basis, from the perspective of the industrial economy, the study on the internalization of regional industrial concentration will focus on “block” (region) analysis. 2.3.4  Measurement of M&A Performance Under Government Competition From the viewpoints of enterprises, M&A are the mode for the external growth of enterprises. For this purpose, this part first takes the industrial or market structure as an exogenous variable to investigate the performance of M&A and their impact factors under the existing market structure of related industries. This is a static analysis of microscopic performance. From the government’s point of view, for specific industries (maturity industries), reasonable industrial concentration based on the trade-off between efficiency and competition (antitrust) is the performance indicator for corporate consolidation. Therefore, this part further takes the industrial market structure as an endogenous variable to examine the impact of M&A on the evolution of the industrial market structure. In addition, based on barriers to entry and the impact mechanism of M&A

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(conglomerate merger) caused by the industrial effects of the industrial cycle on the optimization of industrial structure, this book takes conglomerate mergers in emerging industries as an example for analysis. This is an expanded examination on the performance of M&A. Finally, combining the previous theoretical and empirical study findings, this part proposes a model path for the government to participate in M&A and promote the optimization of market structure. It intends to construct an effective mechanism for M&A and corporate consolidation based on the government competition paradigm and puts forward targeted countermeasures and suggestions, respectively, from the viewpoints of government and enterprises.

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CHAPTER 3

M&A Waves in China: A Survey from the Government Behavior Perspective

The history of corporate M&A in China is a magnificent and mysterious picture scroll in the country’s economic transformation. This chapter intends to draw an outline of and analyze this phenomenal picture from the perspective of government behaviors. It first gives a general empirical description of the wave of M&A of Chinese enterprises and their macro motivations, and then presents a deconstructive analysis of the typical phenomena that form the waves, privatization of local SOEs, local SOEs establishing connectivity with the central SOEs, the reverse takeovers or RTOs, to explore the mechanism of government conducts and the institutional environment on the creation of the waves.

3.1   Existence of M&A Waves in China and the Macro Motivations for the Waves 3.1.1  Empirical Study and Description of China’s M&A Waves In a general sense, the wave of M&A refers to the outbursts of M&A in a certain economy in a given period. Jin Xiangrong (2006) specifically defines the wave of M&A as a large and prominent increase in certain types of M&A at a specific period of time, thus forming events that have great impacts on the industrial economy. A review of the history of M&A in the world may clearly reveal that with the passage of time, the number of M&A in many countries surge and fall on a large scale, and, to some © The Author(s) 2021 F. Wang, M&A and Corporate Consolidation, https://doi.org/10.1007/978-981-15-6675-2_3

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extent, assuming periodic changes. That’s why the “M&A wave” has been used by scholars to depict the periodicity of M&A transactions and for further understanding of M&A activities. Among the views, the most prominent has been that there have been five waves of M&A in the US since its first merger. But for the extensive academic literature, China’s M&A waves, the issue we are more concerned about, has been little touched upon and the conclusions reached are diverse. Then, is there any wave of M&A in China? What factors will affect the occurrence and progress of M&A waves? What role does the government play behind the M&A of Chinese enterprises? We will take these questions as the fact and the logical starting point of this chapter and devote this part to the study of M&A waves in China. 3.1.1.1 Theoretical Analysis and Hypothesis The studies on the M&A waves in China are scarce and the approaches can be roughly divided into two. The first generally gives subjective definitions of M&A waves in China and undertakes analyses from the perspective of historical background and policy environment. The most representative has been Xu Jingxia (2006), where the author believes there have been three waves of M&A in China so far: the first occurred in 1984, that is, it started with the first merger and acquisition in China; the second was formed in 1992, and its policy background was Deng Xiaoping’s speech made on his inspection tour to Southern China, while the third came with China’s entry into the WTO in 2001. The other approach conducts empirical tests based on China’s overall M&A data, and makes classifications and analysis. For example, Tang Shaoxiang (2006) has adopted the three-state Markov regime switching model to conduct empirical studies on China’s overall M&A data, pointing out that China’s overall M&A events are consistent with the model, thus believing that China’s overall M&A events have periodic characteristics. In comparison with the studies in China, more academic explorations have been conducted on M&A waves overseas. The prominent approach has been to adopt the Markov regime switching model to conduct empirical studies on the overall M&A events. Town (1992) is the first to use this model to study relevant issues. It has compared the Markov model with the autoregressive integrated moving average (ARIMA) model and stated that the Markov regime switching model is the best model. Barkoulas (2001) has also used the Markov regime switching model to study M&A in the US, and the model is set to three states. Gärtner (2009) has carried

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8000 6000 4000 2000

Number of Corporate M&As in the US

10000

out an empirical comparative analysis on the M&A waves in the US and the UK.  Tang Shaoxiang (2006) has also employed the model and has found that China’s overall M&A events also have three-state components, all of which satisfy the AR (1) process. However, it should be pointed out that the above studies equate the original hypothesis that there is a wave of M&A with the adoption of the Markov regime switching model to separate different state components, which is somewhat different from our intuitive understanding of M&A waves. For example, the understanding from the reality is that there were three M&A waves in the US between 1960 and 2000, namely, the third in the period of 1960–1970, the fourth in 1980–1990, and the fifth in 1990–2000. Figures 3.1 and 3.2 depict the number and total transaction volumes of US M&A in these three waves. The source of the data is the report published on the website of the US Federal Trade Commission (FTC). From these figures, it can be clearly seen that M&A waves assume the characteristics of a major cycle, while the previous studies where the Markov regime switching model is used for analysis are conducive to scattered periodic components. Therefore, although the Markov model can

1970

1980

Year

1990

2000

Fig. 3.1  Number of corporate M&A in the US in the third to fifth M&A waves

$200B

$600B

$1000B

F. WANG

0

Total amount of US corporate M&As

76 

1970

1980

Year

1990

2000

Fig. 3.2  Total amount of US corporate M&A in the third to fifth M&A waves

be used to estimate the periodic components of the real M&A wave from the frequency domain, it cannot measure and analyze the periodicity and motivation of the M&A wave from the time domain. In many studies abroad, the other approach is to use autoregressive models. Shughart and Tollison (1984) has found with the model that the overall US M&A events generally follow the random walk model, thus believing that the US M&A events have no periodic characteristics. Obeying the random walk model is a special case of AR (1), that is, after verifying that AR (1) is used to fit historical data, if the coefficient is close to 1, it is checked whether the disturbance term obeys the white noise. The point put forward is that, if the random walk model is not satisfied, then it proves that there are cyclical variations in the wave of M&A. Barkoulas et al. (2001) agrees with this point. Golbe and White (1993) has used a similar method for regression, studied the cyclical variations of the overall M&A events through the regression residual terms, and proposed that the periodicity of M&A cannot be judged only by the original data.

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Therefore, to measure the cycle of China’s overall M&A events, we start in this section with the concept of a large cycle of M&A wave, and draw on the models of Shughart and Tollison (1984) and Golbe and White (1993) to carry out AR (1) on China’s M&A activities. The null hypothesis: China’s overall M&A activities do not follow the random walk model and have cyclical components. The alternative hypothesis: China’s overall M&A activities follow the random walk model and have no cyclical components. 3.1.1.2 Data Sources and Descriptions In this section, we have selected the monthly data of the number of M&A and the total transaction volumes of Chinese enterprises as the basis, and obtained the development trend of the average transaction volume of the M&A. Academic studies and the reality show that these three indicators can well describe the overall characteristics of M&A of Chinese enterprises. The samples we select cover the period of January 1994 to December 2012, with 228 monthly sample data in all. China’s first M&A case through capital market transactions occurred in 1994; thus, the novelty and integrity of the data can be ensured. The source of the data is all the M&A deal records from 1994 to 2012 in the Wind database, provided by Wind Information Co., Ltd. (Wind Info), a leading integrated service provider of financial data headquartered in the Lujiazui Financial Center in Shanghai, China. The original data has been processed on the following principles: (1) all cases of unsuccessful M&A are removed; (2) the cases where enterprises, organizations and individuals winning the bid but not being from the Chinese Mainland are removed; (3) the cases where the merged are not enterprises in the Chinese Mainland are removed; (4) a few cases where the total transaction value of the M&A are lacking are removed; (5) all cases of transactions conducted in foreign currencies shall be converted according to the prevailing exchange rate quotation at the time of the transaction; (6) the data are added up on a monthly basis. The necessity of steps (2) and (3) lies in the fact that the data on M&A include some M&A between foreign companies with assets in China, while the total transaction amount does not include the accurate data on the transaction amount of assets in China. An AR (1) is used to fit the overall M&A events in China, namely,

yt   0  1 yt 1   t

(3.1)

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600 400 200 0

Number of Corporate M&As in China

800

where yt is the total number of M&A or the total transaction volume of M&A in the period, while yt − 1 is the historical data of the previous period. Suppose the periodic factor of market is the only factor that may affect the periodicity of M&A, the total transaction volume in this given period is in principle only related to the transactions in the previous period, then other factors can all be disturbing terms εt. Through AR (1), we can test if the coefficient β1 is 1, and if the disturbances can satisfy the classic hypothesis, to see if the M&A events in China are consistent with the random walk model, and hence decide whether the overall M&A in China have periodic features. Figure 3.3 is the Chinese enterprise M&A trend (monthly). As can be seen from Fig. 3.3, the movement of the number of M&A by Chinese enterprises from 1994 to 2004 is relatively mild. By 2004, a large fluctuation had occurred and the first wave crest had appeared, and the fluctuation quantity had also experienced a marked change. This feature can also easily be seen from the depiction of the movement of total transaction amount of M&A of Chinese enterprises in Fig. 3.4.

Jan. 1994

Jan. 1999

Jan. 2004

Fig. 3.3  Number of corporate M&A in China

Jan. 2009

100B RMB

200B RMB

79

0

Total amount of Chineese corporate M&As

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Jan. 1994

Jan. 1999

Jan. 1999

Jan. 2009

Fig. 3.4  Total amount of corporate M&A in China

However, the variation movement for the average value of M&A of Chinese enterprises depicted in Fig. 3.5 is obviously different from those in Figs. 3.3 and 3.4. M&A volume can more truly reflect the intensity of endogenous demand of M&A activities. However, the periodicity of M&A cannot be clearly defined from the figures, so we will in this section provide an empirical test on whether China’s M&A movement can satisfy the random walk model. 3.1.1.3 Empirical Test Before the regression analysis, we conducted the Dickey-Fuller (DF) unit root test on the three items of data. The result (Table 3.1) shows that the three variables are all stationary sequences. The stationarity test has basically eliminated the possibility of pseudoregression, as there is only one explanatory variable in AR (1), and hence the possibility of multicollinearity is also ruled out. For not losing the generality, AR (2) fitting is performed on the three variables, respectively. Table 3.2 shows the regression results of the three variables through AR (2).

0.5B RMB

1B RMB

1.5B RMB

2B RMB

F. WANG

0

Mean value of M&A transactions of individual enterprises in China

80 

Jan. 1994

Jan. 1999

Jan. 2004

Jan. 2009

Fig. 3.5  Average transaction amount of corporate M&A in China Table 3.1  DF test results of three variables Name of variables Total M&A transaction Volume Total M&A transactions Average transaction Amount

T statistics

1% Level

5% Level

10% Level

Test results

−11.588

−3.468

−2.882

−2.572

Stationary

−9.904 −7.398

−3.468 −3.468

−2.882 −2.882

−2.572 −2.572

Stationary Stationary

Table 3.2  AR (2) results of the three variables Name of variables

Lag order

Total transactions

L1 L2 L1 L2 L1 L2

Total transaction amount Average transaction amount

Coe 8.24 −0.94 4.68 1.26 13.11 1.53

P 0.01 0.348 0.01 0.207 0.01 0.127

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The regression results show the three variables are not significant at the second-order lag. Therefore, AR (1) is better than AR (2) in fitting the overall M&A events in China. However, all the estimation coefficients are not 1 and are quite different from 1, which indicates that the overall M&A activities in China are fluctuating with the established trend, so the original hypothesis is accepted. Considering the robustness, we have further tested whether the residual term is autocorrelated. Table 3.3 shows the autocorrelation regression test results of the residual terms at the three-order lag. From the results, there is no autocorrelation in the residual terms of each lag order of the variables except for the average transaction volume of M&A on the third-order lag, which fails to pass the test, so the empirical results are reliable. 3.1.1.4 A  nalysis of the Cyclical Characteristics of the M&A Waves in China Judging from the historical data, Chinese enterprises generally prefer to complete M&A in December for the integrity of financial statements and the reduction of accounting costs. In some years, M&A completed on December 31 have even accounted for more than 1/3 of the M&A deals of the year. Therefore, seasonal factors should be removed in analyzing the real cycle of M&A in China. The M&A occurring in December are then smoothed to 12 months, that is, to use the formula

y tf  1 / 12    yt 6  yt  5 .  yt  yt 1  yt  2  yt  5 



(3.2)

Table 3.3  Three-variable AR (1) residual term autocorrelation test Model variables Total M&A transactions

Total M&A transaction volume

Average M&A transaction volume

Lag order

Q Q

P P

L1 L2 L3 L1 L2 L3 L1 L2 L3

0.04458 0.33995 0.34052 0.11118 1.9469 4.945 0.204 10.195 16.967

0.8328 0.8437 0.9522 0.7388 0.3778 0.1759 0.6515 0.1061 0.0007

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Table 3.4  Smoothed data descriptive statistics Variables

Number of samples

Average value

Standard deviation

Minimum Maximum value value

M&A transactions M&A transactions (smoothed) Transaction volume Transaction volume (smoothed)

228 227

76.01754 75.36137

139.6234 70.21997

0 0

711 209.5

228 227

1,564,017 1,498,146

3,325,738 1,873,936

0 0

2.96E+07 6,151,815

to conduct moving average processing. From the descriptive statistics, the processed transaction amount and the average volume of M&A have not changed significantly, while the standard deviation has decreased by about half. The descriptive statistics are shown in Table 3.4. Table 3.7 depicts the quantity movement of China’s M&A transactions after smoothing, from which a period of growth and two major cyclical changes can be clearly seen, but it is difficult to see the same cyclical changes from Table 3.8 and Figs. 3.6 and 3.7. To remove the low-frequency growth component, HP filtering is applied to the smoothed data deformity. Figures 3.8 and 3.9 depict the quantity movement of the total number of M&A events in China after HP filtering. From Figs. 3.8 and 3.9, it can be clearly seen that from 2004 to 2008, the overall M&A events in China have experienced a trough-peak-trough cycle. The time for the troughs is consistent, so we propose the following hypotheses: H1a: A structural change occurred in China’s overall M&A in 2004. Alternative hypothesis H2b: No structural change occurred in China’s overall M&A in 2004. H2a: A structural change occurred in China’s overall M&A in 2008. Alternative hypothesis H2b: No structural change occurred in China’s overall M&A in 2008. 3.1.1.5 Measurement of Cycles We will take January 2004 and January 2008 as the points of time and judge whether the fixed growth movement of China’s overall M&A events in January 2004 and January 2008 has experienced an abrupt change by testing the stability of the AR (1) model, thus inferring whether these two points of time are the starting point and the ending point of the M&A wave.

150 100 50 0

Number of Corporate M&As in China (after smoothing)

200

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Jan. 1994

Jan. 1999

Jan. 2004

Jan. 2009

60B RMB 40B RMB 20B RMB

Total amount of Chinese corporate M&A events

Fig. 3.6  Number of corporate M&A in China (after smoothing)

Jan. 1994

Jan. 1999

Jan. 2004

Jan. 2009

Fig. 3.7  Total amount of corporate M&A in China (after smoothing)

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100 50 0 -50 -100

The Cyclical Components of China’s Overall M&A Events

Jan. 1994

Jan. 1999

Jan. 2004

Jan. 2009

The Periodic Components of the Total Rransaction Volume of China’s Overall M&A Events -200000 -1000000 0 1000000 2000000

Fig. 3.8  Filtered movement of the number of China’s overall M&A events

Jan. 1994

Jan. 1999

Jan. 2004

Jan. 2009

Fig. 3.9  Filtered movement of total transaction volume of China’s overall M&A events

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The first period is defined as January 1994 to January 2004. The second period is from January 2004 to January 2008. The third period is from January 2008 to December 2012. We use the AR (1) of the three periods to fit the growth movement of China’s overall M&A events:

y1t  y1t 1  1   t1

t satisfying 1, 2, 3 periods

(3.3)

yt2  yt21  2   t2

t  proving time point

(3.4)

yt3  yt31  3   t3

t  proving time point

(3.5)

e’e, e1’e1, and e2’e2, respectively, represent the residual sum of squares in the formulas above, establishing the F statistics F

 ee  e1e1  e2 e2  K ~ F  K ,n  2 K   e1e1  e2 e2  /  n  2 K 

(3.6)

and introduce the dummy variables for regression, that is, to construct the regression formula:

yt  yt 1    Dt   Dt yt 1   t

(3.7)

where Dt is the dummy variable, used to depict the time points for analysis. We set its value as 0 before the time points, and as 1 after the time points, and Dtyt − 1 is the cross term. Using OLS regression, we have calculated the estimated F statistics for residual sum of squares and conducted the OLS regression with dummy variables and cross terms to test the joint significance of the two variables, as shown in Tables 3.5 and 3.6. The results confirm the rationality of AR (1) for analyzing the fixed growth movement of overall M&A events in China. The piecewise estimation F statistics is basically the same as the estimation values for testing the joint significance of dummy variables, thus indicating that the measurement result is reliable. Therefore, it is concluded that the overall M&A events in China in January 2004 and those in January 2008 have undergone changes in trends.

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Table 3.5  Test of China’s overall M&A transaction volume trend First period time window Piecewise estimation F statistics Joint significance of dummy variables Start

End

Jan. 1994 Jan. 1994

Jan. 2004 Jan. 2008

19.41997 34.47042

F value

P value

19.87 29.92

0 0

Table 3.6  Test of China’s overall M&A transaction trend First period time window Start

End

Jan. 1994 Jan. 1994

Jan. 2004 Jan. 2008

Piecewise estimation F statistics

12.86433 8.62382

Joint significance of dummy variables F value

P value

11.61 8.14

0 0.004

Table 3.7  China’s two waves of M&A China’s waves of M&A

Time

Cycle duration

Start

End

First

Jan. 2004

Jan. 2009

Second

Feb. 2008

Unknown

48 Months Unknown

To sum up, we can draw a conclusion that China has had a relatively stable and steady growth period and two relatively complete cycles in its 19-year history of M&A, namely, the wave of M&A, where the steady period ranges from 1994 to 2003, the first wave of M&A covers the period of 2004 to 2008, and the second covers the period from February 2008 up to the present. For details, see Table 3.7. However, is the wave of M&A generated by a pure market cycle? Therefore, we have examined in this section the correlation between the M&A cycle and the GDP cycle. The quarterly year-on-year growth rate from 1994 to 2012 has been obtained from the CSMAR database (a comprehensive database for Chinese business research, which covers data on the Chinese stock market), as shown in Fig. 3.10.

87

10 6

8

GDP Growth Rate

12

14

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Q1 1994

Q1 1999

Q1 2004

Q1 2009

Fig. 3.10  China’s GDP growth rate from 1994 to 2012

Judging from the observable large cycle, the latest complete economic cycle took place from the fourth quarter of 2001 to the first quarter of 2009, with a cycle of about seven years, and its peak occurred in the second quarter of 2007 with a peak value of 14.5. To determine the correlation between the economic cycle and the M&A cycle, we have in this section summed up the monthly historical data of M&A activities and obtained the quarterly number and amount of M&A, and then analyzed the four-order lag correlation coefficient with GDP growth rate. The test results show that all the coefficients are positive, and the overall trend of year-on-year M&A in China is in line with the GDP growth cycle. Judging from the lag order, the greatest correlation coefficient in Table  3.8 comes from the third-order lag GDP and the M&A number sequences, reaching 0.3749. The greatest items in Table  3.9 are the fourth-order lag GDP growth rate and the amount of M&A. The results show that the number of M&A lags behind GDP growth for three quarters and the amount of M&A lags behind GDP growth for four quarters. To sum up, it can be considered that the overall M&A cycle in China lags

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Table 3.8  Correlation analysis of China’s overall M&A and GDP growth rate Variables GDP growth rate Lag first order Lag second order Lag third order Lag fourth order

Number of M&A

Lag first order

Lag second order

Lag third order

Lag fourth order

0.3108 0.3217 0.3441 0.3749 0.3464

0.3091 0.2857 0.3006 0.3216 0.3418

0.3124 0.2826 0.263 0.2766 0.288

0.3187 0.2868 0.2608 0.24 0.2445

0.3277 0.2962 0.2685 0.2413 0.2115

Table 3.9  Correlation analysis of China’s overall M&A amounts and GDP growth rate Variables

M&A amount

Lag first order

Lag second order

Lag third order

Lag fourth order

GDP growth rate Lag first order Lag second order Lag third order Lag fourth order

0.3032 0.4209 0.4181 0.4281 0.4421

0.0991 0.3133 0.4313 0.4258 0.435

0.0482 0.1021 0.3157 0.4313 0.426

0.0115 0.055 0.1082 0.3196 0.435

0.0137 0.0188 0.0616 0.1121 0.3238

behind the economic cycle by about one year. However, this correlation is weak, indicating that the M&A cycle does not depend entirely on the market cycle and the economic cycle. Therefore, it can be inferred that the government has acted as the “other hand” behind the M&A activities. 3.1.1.6 Descriptive Analysis of M&A Waves in China Factors from the market relate the M&A cycle to the economic cycle, but pure market factors cannot well explain the divergence between the two. In the institutional environment of China’s transitional economy, government conducts have a great impact on the generation of M&A waves. It is generally believed that M&A of Chinese enterprises began in Baoding in North China’s Hebei Province and Wuhan in Central China’s Hubei Province in 1984. The M&A activities in these two cities are the first real M&A since China’s establishment of a modern enterprise organization. Prior to this, China also implemented a special form of property right reorganization through the use, restriction, and transformation of private industry and commerce, but this is not enterprise M&A in the general sense, but is purely government conducts.

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In the early 1980s, with the sustained reform of the economic system, China started its first large-scale M&A (Xu Jingxia 2006). This large-scale M&A are basically “relief M&A”, that is, compensatory transferring of the ownership of loss-making enterprises to better-performing enterprises. Therefore, the M&A at this stage are mainly to solve the problem of deficit. Since the M&A activities were carried out between SOEs and the collective enterprises, and the institutional environment of the market economy had not yet been established, local governments were directly involved in the M&A.  At this stage, M&A are mainly conducted intraregionally and in the same industry. The government’s behavioral logic is to seek the bankruptcy replacement mechanism for loss-generating enterprises, instead of promoting corporate consolidation through M&A.  Therefore, the administrative power is the initiator, maker, and sustainer of M&A activities. The relatively steady wave of M&A was activated in 1992 after Deng Xiaoping made his talks on his inspection tour to Southern China and China’s central government set the goal of the market economy system reform. In November 1993, the Third Plenary Session of the 14th CPC Central Committee proposed The Decision of the CPC Central Committee on Several Issues Concerning the Establishment of a Socialist Market Economic System, planning to clarify the property rights relationship and allow the property rights to flow and reorganize. At the time, China’s capital market had just been established, and the acquisition of equity by listed companies was gradually becoming dominant. M&A were gradually developing toward standardization. In the M&A of this period, the government shifted its role from directly promoting corporate M&A to creating an institutional environment for M&A.  The country also started to formulate legal norms for M&A from this time. In this period, the government no longer acted as the direct initiator of M&A, but started its intervention in M&A through the creation of an institutional environment. From Fig. 3.3, we can see that the number of M&A in China increased steadily from 1994 to 2002, but the number increased sharply from 2003 to 2004. After China’s entry into the WTO in 2001, domestic enterprises are facing more intense competition. Through the merger of powerful enterprises, not only are the competitors reduced, but the technology, assets, and management resources of the competitors are obtained; thus, the core competitiveness of the new enterprise is improved. In this period, the government’s role in M&A changed greatly. It was no longer a “matchmaker” and the enterprises have basically realized “free love”. By

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the beginning of this century, the legal environment for acquisition within the scope of listed companies had basically taken shape, that is, a preliminary and complete legal system for the merger and acquisition of listed companies had been established with “Company Law of the People’s Republic of China” and “Securities Law of the People’s Republic of China” as the core, the “Administrative Measures for Acquisition of Listed Companies” as the main body, and other departmental rules, normative documents, and operational guidelines as supplements. Since 2008, affected by the financial crisis, the global economic growth has significantly slowed down. The financial crisis has brought difficulties to some enterprises in their operations. But, meanwhile, the crisis has also led to a market full of opportunities for M&A. On April 18, 2008, the China Securities Regulatory Commission (CSRC) issued the “Measures for the Administration of Major Assets Reorganization of Listed Companies”, another major measure to improve the basic system construction for China’s securities market since the promulgation of the “Measures for the Administration of Acquisition of Listed Companies”. On this basis, China also launched ten programs for revitalization and adjustments of key industries in early 2009, hoping to promote industrial restructuring through M&A of enterprises, enhance industrial competitiveness, and then change the mode of economic development. It is also hoped that China will adapt to profound changes in the world economy by promoting M&A of enterprises, and enhance their capacity to resist risks in the international market. Chinese enterprises have seized the good opportunities and actively implemented overseas M&A. Thus, the number of M&A began to rise after 2009. 3.1.2  Analysis of Motivations for China’s Waves of M&A 3.1.2.1 Theoretical Analysis and Hypotheses The motivation of the M&A wave can be categorized into macroeconomic factors and policy factors, and macroeconomic factors can be subdivided into internal macro factors and external macro factors. Progress has been made in the analysis of the factors affecting the wave of M&A, which can be summarized into three classic theories: the expectancy theory, the economic cycle theory, and interest rate hypothesis. According to the expectancy theory, when enterprises are optimistic about the future economic situation, the manufacturers usually have the motivation to expand their

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production capacity for greater benefits, and M&A of related enterprises, as a major means of expansion, will occur in great numbers. Therefore, optimistic economic expectations will lead to waves of M&A. The theory of economic cycle holds that the occurrence of M&A is closely linked with economic cycles. When the economy is in a booming cycle, manufacturers have the motivation to expand, which will lead to bursts of M&A. When the economy is in recession, manufacturers tend to be more conservative, and carry out prudent management, avoid blind expansion, and the number of M&A will decline. In short, the economic cycle theory maintains that the amount of M&A is in constant fluctuation and changes in the same direction as the economic cycle. The interest rate hypothesis believes that when the interest rate is at a low level, the financing cost of enterprises will be relatively low, and the cost of M&A activities by manufacturers will be relatively low, resulting in the outbursts of M&A, that is, a low interest rate leads to waves of M&A. These three theoretic models were developed in the developed countries of Europe and the US, where the market is already mature. But in China, a country in the transition period of its economy, the government’s behavior, that is, the policy aspect, must be paid attention to. On December 11, 2001, China officially became a member of the World Trade Organization. China’s reform and opening up has entered a new era. Economic data represented by imports and exports have undergone significant changes. A number of manufacturing enterprises are flourishing, bringing unprecedented development opportunities to the country. The reform of split-share structure, which began in April 2005, is an important institutional reform in China’s capital market. Through the reform, stateowned shares that cannot be listed in circulation and some shares that cannot be circulated through other forms can be traded freely through the market. This measure greatly improves the flexibility of M&A, widens the financing channels for M&A, and reduces the financing costs of M&A. Based on the above analysis, we propose the following hypotheses: H1: The number of M&A is positively correlated with the total domestic output, that is, the business cycle theory. H2: The number of M&A is in negative correlation with the interest rate, namely, the interest rate hypothesis. H3: The number of M&A is positively correlated with the stock market capitalization, that is, expectancy theory.

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H4: The reform of split-share structure and China’s entry into the WTO have actively promoted the increase of M&A deals, that is, government behaviors have promoted the waves of M&A. 3.1.2.2 Empirical Studies of the Motivation for China’s M&A Waves In this section, we have, from the Wind database, selected all successful M&A cases in China from the first quarter of 1994 to the fourth quarter of 2012, removed the repeated M&A cases, and obtained the total transactions of M&A and the amount of M&A of listed companies. Our quarterly GDP data, output value of the secondary industry, and output value of the tertiary industry are from the data released by China’s National Bureau of Statistics and the interest rate data come from data released by People’s Bank of China. Among the previous interest rate adjustments, the one-year term loan interest rate adjustment has been more active. The data for the market capitalization of Shanghai and Shenzhen stock markets come from the monthly total market value in the RESSET database (a data platform provider of professional services for model test, investment research, etc., in China), and the quarterly data are obtained by means of an aggregated average. Joining the WTO and the reform of split-share structure are two dummy variables. In this section, a descriptive statistical analysis on the selected data has been conducted, and a stationarity test for items such as the fluctuating output value of the secondary industry, the stock market capitalization, the GNP, and the output value of the tertiary industry (in logs) is carried out (Table 3.10). The stationarity test results show that the interest rate variable is stationary, while the stock market capitalization, the output value of the secondary industry, the output value of the tertiary industry, and GDP fail to pass the test. Therefore, after their first-order difference, another Table 3.10  Stationarity test of time series data Name of variables

Stationarity test

Stationarity test after first-order difference

Interest rate Total market capitalization Output value of secondary industry Output value of tertiary industry GDP (LOG)

Stationary Not stationary Not stationary Not stationary Not stationary

– Stationary Stationary Stationary Stationary

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stationarity test is conducted. The test results show that the processed variables are all stationary. In terms of the explained variables, we have selected in this part the total number of M&A in China and the number of M&A of listed companies in China, but the total M&A transaction value is not included in our analysis for the problems of statistical caliber and data availability. The co-integration test results reveal that the stationary data can be regressed. So after setting the reform of split-share structure and China’s WTO entry as two dummy variables, a basic model is established: M & At  1GDPt   2 RATEt   3 SMVM t   4 STORC   5 JWTO   t (3.8) where M&A is the number of M&A (the number of M&A of listed companies) in the year of the reform and the WTO entry, GDP is the nominal GDP for the quarter, RATE is the interest rate for the quarter, SMVM is the stock market value, STORC and JWTO are the dummy variables of the split-share structure reform and China’s entry into WTO. From the regression results, we can see that the change of interest rate in all models, except Model (5) and Model (6), has a significant impact on the number of M&A (the number of M&A of listed companies) of the explained variables, and the estimation coefficients are all negative, which indicates that the interest rate hypothesis is tenable in the studies of M&A in China, that is, low interest rate has facilitated M&A of Chinese enterprises. Models (9), (10), (11), and (12) have shown that the effects of interest rate on unlisted companies are generally more significant than on listed companies. Listed companies are less affected by the change in interest rates, which means that there are other effective channels for listed companies in China to conduct M&A financing. With the rise of M&A means like equity swap through the capital market, the traditional financing methods that rely on banking will be changed to some extent. As for the theory of expectation, our empirical results show that it is not tenable in the studies of M&A in China. It is not difficult to find from Models (1), (2), (5), and (6) that the estimation coefficient of the stock market value is not significant. The fluctuation of the stock market does not exert a constant influence on the M&A of Chinese enterprises. Compared with the developed capitalist countries in Europe and America, China’s capital market is immature, which makes it difficult for Chinese enterprises to conduct M&A through direct financing in the capital market.

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Our empirical results also show the cycle theory is tenable in China’s M&A market. All our models show that GDP (the output value of the secondary industry and the output value of the tertiary industry) plays a significant role in M&A and has a positive correlation with M&A in China. Judging from the coefficient, listed companies are slightly less affected by GDP than listed companies as a whole, which shows that listed companies are less affected by GDP than unlisted companies. To a certain extent, this is due to the fact that listed companies, as China’s top enterprises, have sufficient funding sources and vast foreign market, and are slightly less affected by cycles than unlisted companies. In terms of significance, the output value of the secondary industry has the most significant impact on M&A. Although the output value of the tertiary industry has a significant impact on the number of M&A, the coefficient is very low. Regarding the reform of the split-share structure system, our conclusion is that it has significantly affected China’s M&A market. From Model (3) to Model (12), all tests of the variable of the split-structure system reform can be significantly positive at the level of 1%. It should be noted that the reform is a long-term process from the beginning to the thorough promotion of the reform, and then to the end of the reform. Based on other proven theories, we can find that the significance of the split-share system reform lies in the fact that as a policy expectation of the central government, it shows the government’s support for M&A. Therefore, the reform may have a stronger push for M&A than market factors and the impact may also be stronger than what has been reflected in the statistical results. China’s entry into the WTO is also an important event in the history of M&A in the country. From the empirical results, it can be found that the impact of the event is significant and its correlation with M&A is positive. However, Models (5) and (6) have shown that the impact of China’s entry into WTO on listed companies is significant, but it is not significant for the companies as a whole, indicating that the listed companies as a whole are what have been greatly affected. Under the background of “emerging economies” and “economic transition”, M&A in China always have the lingering hand of political power behind them. The fact that the relevant classic theories on M&A are not tenable in our studies also confirms that there is a strong non-market intervention force behind M&A in China.

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3.2   Privatization of Local SOEs from the Perspective of Government Control Rights Transfer Since the 1990s, China has started to carry out the reform of its stateowned enterprises, which is “invigorating large enterprises while relaxing control over small ones” and “strategic adjustment of the economic structure”, bringing about the privatization of a large number of SOEs. The growth of China’s securities market makes hostile M&A less likely, and the controlling shareholders have an absolute say in M&A or control rights transfer. So what are the motivations for governments at all levels that have ultimate control to choose to transfer or continue to have control over SOEs? Apart from the traditional motivations for M&A, are there any other specific motivations for the transfer of control rights in China? We will in this section start from the privatization of local SOEs and explore the motivation and behavior mechanism of local governments’ transfer of control rights. This is of great significance for a clear understanding of the reform of China’s SOEs. 3.2.1  Motivations for Government to Transfer Their Control Rights of Enterprises 3.2.1.1 R  elevant Studies on the Government’s Motivations for Control Rights Transfer In China, the control rights of most state-owned listed companies belong to local governments at all levels. In addition, before the reform of the split-share structure, the state-owned shares are forbidden to be sold, which makes hostile M&A or the transfer of control rights in the market less feasible in China. Therefore, the transfer of control rights in the country is more a manifestation of the motivation of local governments at all levels. Of course, as a kind of special M&A behavior, the control rights transfer can be interpreted with some Western M&A motivation theories. For example, Li Shanmin and Zeng Zhaozao (2003) have studied the samples of listed companies that have made paid transfer of control rights in 1999–2001 in China and summarized the characteristics of these companies, such as low efficiency of management and relatively small scale of assets. Obviously, the traditional Western M&A theories can also explain the motivation for the transfer of control rights in China, but we will in

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the following place particular emphasis on the studies of the motivation of all levels of government in the transfer of control rights in China. Wang Honglong et  al. (2001) have summarized the motivation for governments at all levels in China to give up control over SOEs from a theoretical perspective. They hold that the first motivation is the economic efficiency of the enterprise, that is, the government gives up or transfers the control rights of an SOE to improve the operating efficiency of the enterprise; the second is the government’s fiscal revenue, that is, the government gives up or transfers the control rights not only to relieve its financial burden on loss-generating SOEs, but also to obtain an increase in fiscal revenue brought about by improved performance of the enterprises after the transfer; the third is the strategies of political games, that is, the government gives up or transfers control rights of SOEs for its own strategic purposes such as industrial structure adjustment or industrial upgrading and optimization. These are also the three mainstream views on the government’s abandonment of control rights of SOEs in China. Meanwhile, empirical studies on the motivation of the government giving up the control rights of enterprises are also carried out in China. Xia Lijun and Chen Xinyuan (2007a, b) have taken the listed companies controlled by the local governments in China from 2001 to 2003 as the research objects and found that regional marketization has reduced the economic motivation of the local government’s control over the enterprises, while the central government’s SOE reform strategies of “invigorating large enterprises while relaxing control over small ones” and “strategic adjustment of economy” have given the local governments political motivations to control large-scale companies and regulatory industry companies. Hu Yifan et al. (2006) and Liu Xiaoxuan and Li Liying (2005), based on ex post facto studies, have inferred the economic motivation for governments at all levels to give up the control rights from the perspective of the SOEs’ performance improvement after their privatization. The Development Research Center of China’s State Council released in 2005 an empirical study on the privatization and restructuring of SOEs in China. The study has found that the restructuring is usually the result of the government’s choice for the maximization of regional interests. Therefore, in reality, it is more common to see “the ugly married off first”, that is, the enterprises with poor performance or even losses are privatized first. This reflects the economic motivation of all levels of government. Sun Ye and Luo Danglun (2011) have conducted a study on the samples of seller-initiated control rights transfer of “shell resources” of

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state-owned listed companies in China and have found that local governments tend to transfer SOEs with good performance and great influence to local private enterprises, but to transfer SOEs with poor performance and little influence to non-local private enterprises. This intervention with the sense of local protectionism reflects the political motivation of local governments in the transfer of control rights. Zhao Yong and Zhu Wuxiang (2000) also believe that the motivation for M&A of listed companies in China is in line with the actual situation of backdoor listing by studying the samples of control rights transfer in China. Tan Jinsong et al. (2009), by sorting out the reorganization cases of the listed companies in the Shenzhen stock market from 1996 to 2004, have found that the listed companies under the administration of Shenzhen municipality have gone through two stages in their reorganization: passive reorganization for lossmaking enterprises and industry-initiated active reorganization. The conclusions of Chinese scholars on the motivation of control rights transfer in China are relatively consistent. They believe the current control rights transfer in China has not only traditional economic motivations like eliminating losses and improving performance, but also special political motivations of all levels of governments. 3.2.1.2 A  nalysis of the Motivations of Government Control Rights Transfer from the Perspective of Regional Public Governance The above review of the relevant studies on the motivation of control rights transfer in China clearly shows that the previous studies on the issue are short of clear theoretical bases for the analysis of the motivations. As a new economy in transition, China’s special institutional background will inevitably lead to differences in the theoretical interpretation of the motivations of traditional M&A. We will in this part take the institutional environment of local state-owned listed companies in China into consideration and, by taking the local governments as regional administrators, theoretically analyze the motivation of the transfer of government control rights of local state-owned listed companies in the country from the viewpoint of regional public governance. Under the traditional planned economy system, the local governments in China act more as a policy enforcer and do not have too many rights for policy-making. However, after the fiscal decentralization reform in 1994, the local governments have become relatively independent economic

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subjects, owning a part of the fiscal revenue and exercising certain control over the revenue. Meanwhile, they are required to take on more economic management and regional social management responsibilities, and have started to carry out the public governance of the region as a regional administrator. This is the public governance theory held by Chinese and foreign scholars. Therefore, we will in this part choose the public governance theory for our analysis of the motivation for local government’s M&A decisions. Following the definition given by Tan Jinsong et  al. (2009), we refer to the public governance of local government as the functions and responsibilities of local governments in developing the local economy, serving social welfares, and maintaining social stability within their jurisdictions. Local state-owned listed companies are the objects of public governance by local governments. Meanwhile, due to the public nature of listed companies, their operation will often become the basis for the central government and the outside to evaluate the effectiveness of government public governance. Therefore, the local governments with the ultimate control will inevitably intervene in or even affect the major merger and reorganization decisions of local state-owned listed companies and their transfer of ownership. In other words, the government control rights transfer of the local state-owned listed companies represents the decision and motivation of the local government with ultimate control, and the different government motivation leads to different M&A decisions made by the local government. In addition, the special background of China’s centralized system and the increasingly intense horizontal competition between local governments often make the local governments in China constrained and restricted by the central government and other local governments at the same level when making economic decisions. Based on the above considerations, we have established in this part an analysis framework for the transfer of government control rights of local SOEs in China from the perspective of public governance, as shown in Fig. 3.11. The objectives of local government’s public governance can be broadly divided into three categories: political, social, and economic. All decisions of local governments are the result of an overall consideration of these three objectives under the institutional environment of the policies of the central government and horizontal competitions between local governments. From the viewpoint of public governance, the local government behaviors serve to satisfy the public governance objectives of local governments. The special institutional background of China is not for hostile M&A. This

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Fig. 3.11  Analysis framework for the local SOE control rights transfer under regional public governance

enables the local governments, the ultimate controller of local state-owned listed companies, to make M&A decisions of these companies. Therefore, we see that the transfer of control rights of local state-owned listed companies is in line with the objectives of local governments’ public governance. Different motivations may lead to different M&A decisions from the local governments. In this part, following the model of Wang Hongling et al., we establish the revenue function of local governments for enterprises: WG = αe + βT + B, where e represents the economic efficiency of local enterprises (state-owned or private), T is the tax paid by local enterprises (when the enterprise is state-owned, T can be negative, meaning the government has fiscal subsidies for the SOE), B is the public interests in the control of governments (it is 0 when the enterprise is private). The three factors are consistent with the objectives of the local governments’ public governance. Based on the analysis of the revenue function, we believe the motivation for the local governments to abandon or transfer the control rights of state-owned listed companies depends on the weight of the relations among the three. (1) Local governments have the motivations to transfer or abandon their ownership of enterprises, thus improving the economic efficiency of enterprises. The local governments are the ultimate controller of local state-owned listed companies. Based on whether they directly participate in the operation and management of enterprises, the local SOEs can be divided into

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enterprises under the direct control of the government and enterprises managed by SOEs directly subordinate to the government or asset management companies under the local governments. Both types are facing the dilemma of poor management and weak cost control awareness, which leads to poor business performance. The second type, which is under the indirect control of local governments, also faces the agency issues of the government and the agency managers. Therefore, rational local governments will choose to give up or transfer the control over SOEs, that is, to improve the operating efficiency of these enterprises through privatization, a common interpretation for the motivation of the transfer of government control rights in previous studies, which is referred to as efficiency theory for short. (2) Local governments have the motivation to give up loss-making enterprises, reduce financial subsidies, and increase fiscal revenues. Under the current central and local tax distribution system in China, tax revenue constitutes a major part of local fiscal revenue. However, the losses caused by the low production efficiency of local SOEs are generally made up by the local governments in the form of direct or indirect tax reduction and exemption or financial subsidies, which undoubtedly increase the local governments’ financial burdens. Therefore, the government tends to transfer the control rights of loss-making enterprises for the purpose of increasing fiscal revenue. This is another common explanation on the motivation of the transfer of government control, which is referred to as income theory for short. Efficiency theory and income theory embody the economic goals of local government’s public governance theory. (3) To gain the political benefits of SOEs, local governments usually retain the ownership of large-scale enterprises in regulated industries. Moreover, based on the political game between regions, they tend to favor congeneric M&A. Although the government’s transfer of control over SOEs can bring about economic benefits, the political benefits for SOEs will be reduced at the same time. So the local government needs to weigh the economic benefits and political benefits. The political benefits of local government for SOEs can be roughly summarized as the political and social goals of local governments. The social objectives are mainly reflected in the stabilizing effects of SOEs on the local employment rate, as employment is an

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important prerequisite for social stability. So, the facilitation of employment rate from SOEs is an important factor for the local governments to make M&A decisions. The local governments will inevitably consider the impact on local employment when making decisions on the transfer of their ownership of SOEs. They tend to retain government control rights over larger enterprise groups. The political objectives are relatively diversified. Firstly, to achieve political stability, the local governments usually do not transfer control of enterprises in regulated industries such as oil and natural gas. Secondly, the institutional environment of the local governments also has a significant impact on their decision-making on the transfer of control rights. Since the reform of fiscal decentralization in China, the competition among local governments over mobile factors like technology and resources has intensified. Meanwhile, the local government performance evaluation system with GDP as the core has intensified the competition among local governments over enterprise resources, particularly listed companies. For the late start of China’s securities market, the stock issuance system in the country is also in the stage of constant improvement. Under the previous examination and approval system and the authorizing system, the number of companies approved to be listed each year is limited. Against this background, the scarce “shell resources” have become an extremely important resource for local governments that have ultimate control rights. Because of this, local governments will intervene in the flow of “shell resources” to maximize the interests of their jurisdictions, that is, they will give priority to congeneric M&A.  Many political factors have led local governments to retain control over large-scale and key enterprises, and are more inclined for congeneric M&A.  This also reflects the political and social goals of local government’s public governance. The author believes that the institutional setting and the policies of the central government and other local governments at the same level will also affect a local government’s decision on the transfer of control rights of SOEs in its jurisdiction. First of all, the local government is directly under the jurisdiction of the central government at a higher level. Therefore, various policies of the central government will directly affect the decisionmaking of the local government. Regarding the transfer of control rights of SOEs, the central government’s policies or guidelines on reforms of SOEs will directly affect the local government. Since the 1980s, the central government has successively formulated strategies for the reform of SOEs, such as “granting decision-making power to enterprises and allowing them to keep more profits”, and the contract responsibility system, but with little effects. It was not until 1995 when the strategies for SOE

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reforms were put forward at the Fifth Plenary Session of the 14th Central Committee of the Communist Party of China (CPC), calling for “invigorating large enterprises while relaxing control over small ones” and “strategic adjustments”, that the reform routes of SOEs in the country were determined. Subsequently, the establishment of the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council in 2003 and the split-share structure reform in 2005 kicked off the restructuring of SOEs in China. The so-called “invigorating large enterprises while relaxing control over small ones” means that the government should focus on a group of large enterprises and enterprise groups, give full play to their backbone role in the national economy, and, meanwhile, depending on different situations, speed up the pace of reform and restructuring of small SOEs by means of reorganization, combination, merger, share consolidation, lease, contract operation, and sale. The strategy of “strategic adjustment” means that the government should maintain absolute control over state-owned economy concerning industries that are related to national security and the lifeblood of the national economy, and the provision of important public goods and services, as well as high-tech industries, while it can gradually withdraw from other industries and fields. We will in this section, adopting the models of Xia Lijun and Chen Xinyuan, refer to the former category of industries as regulated industries and the latter category as non-regulated industries. The regulated industries include the sectors of mining, petroleum, chemistry, plastics, synthetic resin, metals, non-metals, the production and supply of electricity, gas, and water, transportation, warehousing, and information technology. It follows that the central government’s SOE reform strategy and the local government’s political and social goals of public governance are complementary to each other. On the whole, the central government’s SOE reform policies can exert influences on the local government’s decision to transfer the control rights of local SOEs mainly in two aspects: the size of enterprises and the characteristics of industries. As a result, the local government has the motivation to transfer the control rights of state-owned listed companies that are small in scale and in non-regulated industries while retaining the control over enterprises that are large in scale and in regulated industries. This is also the embodiment of political and social goals in the role of local government in public governance.

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3.2.1.3 H  ypotheses of the Motivation for the Local Governments’ SOE Control Rights Transfer in China Previously, we have made theoretical analyses of the motivation of local governments to transfer the control rights of SOEs from the perspective of public governance; in the following section, we will propose relevant hypotheses. Both the efficiency theory aimed at studying economic efficiency and the income theory aimed at exploring fiscal revenue are based on the analysis of local government’s economic interests, which reflects the economic objectives of local government’s public governance. Referring to the studies by Chinese scholar Yang Jijun (2010), we will refer to two viewpoints as the economic motivations of local governments to transfer government control over enterprises. And in this part we propose the following hypothesis on the business performance of enterprises: H1: If the business performance of an SOE is relatively poor in the past, the local government tends to transfer the control rights of the enterprise, and privatization of the enterprise is more likely to take place. The pressure from the central government’s policies and the consideration of the political benefits of the local governments make the local governments in China show their unique political motivation to retain large and key enterprises when making transfer of enterprise control. We here put forward the following research hypotheses on scale, industry attributes, and regions: H2: If the size of an SOE is small, the local government tends to transfer its control rights, and its privatization is more likely to take place. H3: If an enterprise is in the non-regulatory sector, the possibility for the local government to transfer the control rights of the SOE is higher, and privatization of the enterprise is more likely. H4: The local governments are more inclined to transfer smaller enterprises with poor performance out of their jurisdiction and to other places.

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3.2.2  Empirical Studies of the Motivation for Government Control Rights Transfer 3.2.2.1 Obtaining and Screening Samples The window period for the empirical studies in this section covers the period from 2003 to 2009, and the study objects are the local state-owned listed companies that have undergone control rights transfer during the period. The data comes from CSMAR databases for the auction and transfer of stateowned shares. The screening standards for the data are as follows: (1) On the basis of the alterations of the largest controlling shareholder and the ultimate control rights, the samples that have not led to the transfer of the enterprises’ control rights shall be removed. (2) The samples where the target enterprises are under the control of the central government are removed, and only the local state-owned listed companies are retained. (3) The samples of enterprises where the ownership is transferred to the central government or foreign-funded enterprises are removed. (4) The samples where multiple control rights transfers have taken place during the window period are removed. (5) The samples where the enterprises have been delisted are removed. (6) The samples where the enterprises are listed on the B-share market are removed. (7) The samples of enterprises in the financial and insurance sectors are removed. After the above screening, 211 eligible samples were selected. Table 3.11 shows the transaction time and industries of the 211 sample companies. In terms of the time for transaction, the period from 2003 to 2006 is an intensive period and transactions have decreased after 2007. In terms of industries, most of the enterprises with control rights transfer are in the manufacturing industry, while wholesale and retail businesses and real estate industry are also industries with more control rights transfer. Following the models of Chinese scholars, we have selected the return on assets (ROA) and the assets size of listed enterprises to measure their financial performance and the scale of the companies. The specific data come from the financial index database of listed companies by CSMAR. Some missing financial data are found by the author from the annual reports of listed companies. As for whether the enterprises are classified into regulated industries, we refer to the studies of Xia Lijun and

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Table 3.11  Transaction time and industries of samples Industries Agriculture, forestry, animal husbandry, and fishery Extractive industry Manufacturing Petroleum, chemistry, synthetic resin, plastics Metal, non-metals Production and supply of electricity, gas, and water Construction Transportation and warehousing IT Wholesale and retail Real estate Social services Communication and culture industries Miscellaneous Total

2003

2004

2005

2006 2007

2008 2009 Numbers

1

2

13

3 21

12

3 23

13

14 1

2 1

1 3

1 2

1 2

2

1

1 1

1

2 3 3 3 2

1 28

9 5 1 1

44

2

2 5 9 2

3 1 1

1 27

1 49

3 24

1 6

7 102 1 7 9

2 1

4 5

2 2 3

1

7 26 24 6 1

1 28

11

1

4 2

5

7 211

Chen Xinyuan (2007a, b), holding that regulatory industries cover industries in extractive industries, petroleum, chemistry, plastics, synthetic resin, metals and non-metals, production and supply of electricity, gas, and water, and transportation, warehousing, and information technology, and the other enterprises belong to non-regulated industries. Our data of indexes related to characteristic factors of control rights transfer, such as the form of control rights transfer, terms of payment, privatization or not, related-party transaction or not, come directly from the state-owned shares auction and transfer database of CSMAR. As for whether the transaction is congeneric, we have made inferences by looking up the registration places of the targets and the mergers and have integrated whether the sample enterprise has been privatized for the classification of the types of control rights transfer. 3.2.2.2 Empirical Study Method and Descriptive Statistics of Data Based on the hypotheses on the motivation of government control rights transfer put forward in the previous section, we will in this part conduct empirical analysis by establishing the Logit regression model. Taking into account the background of SOEs in China and the modes of government

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intervention, we believe that the local government, as the transferor of control rights, controls the transfer of SOE control rights mainly in the aspect of the transfer direction. Referring to the hypotheses proposed above, we follow the studies by Yang Jijun et al. (2010), and select the different ownership and regional attributes of the transferee to represent the motivation of local government’s transfer of government control over SOEs. To be more specific, the empirical Models (3.9, 3.10 and 3.11) established in this section are as follows:



type    1 past _ roa   2 past _ size   3regulate   4 direct   5region  



private    1 past _ roa   2 past _ size   3regulate   4 direct   5region  



province    1 past _ roa   2 past _ size   3regulate   4 direct   5region  

(3.9)



(3.10)





(3.11)

where “type, private, and province” are dummy variables. Their respective meanings and values are shown in Table 3.12. “Past_roa and past_size” are the average of ROA and the average size of enterprises in the past two years. “regulate” is a dummy variable indicating whether the enterprise is in the regulated industry or not; 1 means it is, and 0 means it is in the nonregulated industry. In addition to the three explanatory variables, the manifestation of the motivation for the local governments’ control rights transfer is also affected by whether the local state-owned listed companies are directly controlled by the government. So the dummy variable “direct” is included for evaluation, where 1 means direct government control, and 0 means indirect government control. The level of marketization also affects the government’s behaviors. So the dummy variable “region” is introduced for the evaluation of the regional distribution of the target companies, where 1 means in Eastern China and 0 means in Central or Western China. Table 3.13 gives a descriptive statistical analysis of the indicators used to test the economic and political drivers of the government’s transfer of control rights. Panel A provides statistics on whether the ultimate control

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Table 3.12  Definition and values of dependent variables Dummy variables Type Private Province

Values 1 0 1 0 1 0

Meaning The ultimate control is not altered Transferred to other governments or privatized Privatized Transferred to SOEs Transferee local Transferee non-local

Table 3.13  Descriptive analysis of data Panel A Types

Number of samples

1=Ultimate control 103 Unchanged 0=Ultimate control 108 changed Mann-Whitney U test Z value Panel B Private

Number of samples 89 122

1=privatization 0=SOE restructuring Mann-Whitney U Test Z value Panel C Province

Number of samples 154

1=Congeneric transaction 0=Cross-regional 57 transaction Mann-Whitney U Test Z value

Regulated industries

past_size Mean Median

20

21.33

21.248

16

20.759

20.719

Regulated industry 11 25

Regulated industry 25 11

past_roa Mean Median 0.041 −0.01

0.041 0.026

3.269**

3.802**

past_size Mean Median 20.786 20.736 21.223 21.096

past_roa Mean Median −0.01 0.031 0.034 0.038

2.931**

2.716**

past_size Mean Median 21.168 21.071

past_roa Mean Median 0.017 0.038

20.673

0.012

20.671

2.824**

0.028

2.196*

Note: **, * in the Mann-Whitney U test Z value indicates the significance levels of 0.01 and 0.05, respectively

rights have changed, from which it can be found that in 103 samples, the ultimate control rights remains unchanged, that is, the government continues to retain the ultimate control rights of these local state-owned listed companies, and the past average enterprise size and performance index of

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these samples are obviously better than the other 108 samples that have undergone the change of ultimate control rights. From the statistical data analysis, the local government in reality tends to keep within its control the enterprises with better performance and larger size. Panel B presents statistics on whether privatization of the enterprises has taken place. The number of samples for privatization is 89, but the proportion of privatized enterprises in regulated industries is obviously lower than that of SOE reorganization. Meanwhile, the average enterprise size and performance index of the privatized enterprises are also lower than that of the samples that have not undergone privatization. The statistical data analysis reveals it is more likely for local governments to transfer the control rights of enterprises with poor performance and of small size to private enterprises, and the probability of privatization of enterprises in regulated industries is smaller. Panel C presents a statistical analysis on the data of congeneric transactions. From the quantitative analysis, the possibility of the congeneric M&A transactions is far greater than the possibility of cross-regional M&A transaction. Moreover, enterprises in regulated industries are more likely to conduct congeneric M&A transactions. And the average enterprise size and average performance index of the 154 samples which have undergone congeneric M&A transactions are also higher than those of 57 samples of cross-regional transactions. From the statistical data analysis, the local governments are more inclined to conduct congeneric M&A transactions, and tend to transfer enterprises with poor performance to other places. The political and economic motivations of local governments’ transfer of their control rights over local state-owned listed companies are somewhat represented in the descriptive statistical analysis of the data. 3.2.2.3 E  mpirical Test of the Motivation for Government Control Rights Transfer For the empirical test, we will divide the samples into two parts (with 99 samples for the years 2003–2005, and 122 samples for the years 2006–2009) with the year 2005 as the dividing line as this was the year for the start of China’s split-share structure reform. And since our study covers the period of 2003–2009  in which the motivation of local governments may show different directions as time goes on, the division can visually reflect the motivations and their trends with the time. We will conduct Logit model regression of the two groups of samples, respectively, and the empirical results are shown in Table 3.14.

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Table 3.14  Empirical results of motivations for control rights transfer Explanatory variables c past_roa past_size regulate direct region R2

Model 1 (type)

Model 2 (private)

Model 3 (province)

Before

After

Before

After

Before

After

−4.1963 (0.5288) 4.0299** (0.0134) 0.1901* (0.0528) 0.1238 (0.8270) 0.8372 (0.0749) 0.1848 (0.6762) 0.4040

−2.5112*** (0.0002) 1.9502** (0.0425) 1.0195*** (0.0002) 0.9321*** (0.0063) 0.3217 (0.5026) −0.0842 (0.8531) 0.5625

3.4183 (0.6013) −4.6092** (0.0383) −0.1760 (0.5759) 0.2217 (0.6923) 0.7641 (0.0934) 0.3210 (0.4667) 0.5354

3.4743*** (0.0095) −0.5608* (0.0627) −0.6641*** (0.0077) −1.7710** (0.0256) −0.3635 (0.4680) 0.1661 (0.7234) 0.6214

−2.2068* (0.0994) 0.6502** (0.0119) 0.6168* (0.0842) −0.5321 (0.3639) 0.3360 (0.4864) 1.1360** (0.0218) 0.6869

−9.6887* (0.0699) 0.2642* (0.0550) 0.4990** (0.0418) 0.2481** (0.0423) 0.1624 (0.7649) 0.4419 (0.3541) 0.7679

Note: In the table, the figures above are the coefficients estimated, the figure in the brackets under them are the p values; ***, **, * mean the explanatory variables have passed significance levels of 0.01, 0.05, 0.1, respectively

As is shown in Table 3.14, the estimation coefficients of “past_ roa”, the past performance of the enterprises before the split-share structure reform, all passed the 5% significance test in the three models, which has confirmed the hypothesis H1 on economic motivation proposed in this section, that is, the local governments tend to transfer the enterprises with poor performance and the possibility for these enterprises to be privatized is greater. However, the conclusions for the two explanatory variables “past_size” and “regulate”, which are used to reflect the political motivation of the local governments, are not consistent in the three models. Among them, “regulate”, the regulated industry variable, has not passed the significance test in all three models, while “past_ size”, the past size index variable, has passed the 10% significance test only in the cases where the control rights have been transferred and where congeneric transactions have occurred, that is, the local governments are more inclined to retain large-scale enterprises within their own jurisdiction and keep their control rights. The empirical results partially verify the hypotheses H2 and H4 proposed in this section on the political motivation of the transfer of control rights of local governments, and there is no sufficient evidence to support H3. Based on the results of the three models, we believe that before the split-share structure reform, the transfer of control rights of local state-owned listed companies in China reflected the economic

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motivation of the local governments, while the political motivation was only reflected in the enterprise size, and the degree of influence was obviously smaller than the enterprise performance. Hence we can conclude that before the split-share structure reform, the intervention of local governments in the transfer of control rights of SOEs reflected the local governments’ economic and political motivations, with economic motives being dominant. After the split-share structure reform, past_ roa, the performance indicator used to reflect economic motivations in the three models, has passed the significance tests in different degrees, indicating that the local governments still have economic motivations to keep enterprises with sound performance within their own control. However, judging from its degree of impact, the estimation coefficients are obviously smaller than those before the reform, and the significance level has also decreased. Hence, we can conclude that, after the split-share structure reform, the intervention of local governments for economic factors has decreased. But the indicators of “past_size” and “regulate”, used to reflect the local governments’ political motivations for intervention in M&A, have increased and have at least passed the 5% significance test. This shows that after 2005, the political motivations for local governments’ intervention have begun to play a role, leading the local governments to privatize small enterprises in non-regulated industries while retaining control over large-scale enterprises in regulated industries. This political motivation is also reflected in regional decision-making. The local governments are inclined to retain large-scale enterprises in regulated industries within their jurisdiction. It goes to show that the economic motivation for local governments’ intervention in M&A after the split-share structure reform is still reflected, but its impact has obviously decreased, and the political motivation turns to be more prominent than before the split-share structure reform, showing a change in political motivation playing a major role and the economic motivation a minor role.

3.3   The “Connectivity” of Local SOEs with the Central SOEs: From the Perspective of Local Government Competition In recent years, the privatization of SOEs in China has slowed down, but the transfer of local SOEs’ control rights to the central SOEs has frequently occurred. Such transactions cannot be separated from the participation of the local governments, who are generally the controller of the

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local SOEs. In this part, we will link this with China’s fiscal decentralization system. And starting from the perspective of local government’s competition under the fiscal decentralization system, we will construct a dynamic game theoretic model to give an interpretation to the theoretical motivation for the connectivity of local SOEs with the central SOEs. Based on the relevant data of China’s local state-owned listed companies on the A-share market, we will empirically verify the impact of local governments’ competition on the transfer of SOE control rights to the central SOEs through the use of the Logit model empirical test and the construction of the “local investment invitation gap”, a variable measuring the efforts of local governments in the competition. 3.3.1  “Connectivity” of Local SOEs and the Central SOEs: Progress and Current State SOEs have played an important role in China’s national economic development, and their reform is also one of the important fields of China’s economic system reform. After the reforms highlighting “granting decision-making power to enterprises and allowing them to keep more profits” and “the contract system”, the State Council put forward in 1993 the goal of establishing a modern enterprise system for SOEs. Since then, the reform of SOEs has entered the stage of system innovation. With the establishment of the SASAC in 2003 and the establishment of the regional SASAC in the country’s 31 provincial administrative areas and the Xinjiang Production and Construction Corps in 2004, the problem of the absence of owners of SOEs in China has been solved, and the boundaries between the “central forces” and the “local forces” of SOEs have gradually become clear. At the beginning of the reform of SOEs, the policies of “granting decision-making power to enterprises and allowing them to keep more profits” and “the contract system” were actually a kind of system arrangement for moderate privatization. At the stage of system innovation, SOEs officially began to take the path of privatization. The decade of 1992 to 2002 witnessed a period of the fastest progress of privatization and the fastest progress of marketization in China. The reform at this stage has achieved remarkable results. However, after 2003, the privatization of SOEs has started to slow down, while the transfer of control rights of local SOEs to the central SOEs is increasing day by day. Especially for the past few years, the central SOEs have “gained grounds” and acquired local SOEs frequently.

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Facing the “enclosure movement” of the central SOEs, the local governments are not resisting the integration of the local SOEs by the central enterprises; on the contrary, they actively seek for the connectivity of the local SOEs with the central enterprises. Some local governments even held large-scale promotions in Beijing for the connectivity of the local SOEs with the central enterprises. According to statistics in the magazine of Shanghai Guozi, in the year 2009 alone, at least nine provinces, including Anhui and Zhejiang, held activities for the connectivity of local SOEs with the central SOEs.1 Provinces, not only the economically underdeveloped in Central and Western China, but also the more economically developed in Eastern China, have a strong impulse to align with the central enterprises. And the connectivity is “fully blossoming”. According to the data of cooperation between the central enterprises and the local SOEs released by 27 provincial administrative areas in the country (excluding Beijing, Shanghai, and the Tibet Autonomous Region), and the incomplete statistics by Yicai (China Business News Daily), the investment of the central enterprises in the provincial administrative areas increased by 42 times in the four years from 2008 to 2011.2 However, the industries for investment include not only enterprises in electric power and energy that are related to national security and the lifeblood of the national economy, but also some competitive fields, such as the sectors of modern services and food. This all-round expansion of the central SOEs is bound to affect the economic environment of China’s state-owned economy represented by the central SOEs, the local state-owned economy, and the non-stateowned economy. Figures  3.12 and 3.13, respectively, show the change since 2003 in the number of enterprises and the total assets of enterprises of the non-financial industry listed in China’s A-share market, the ultimate controllers of the enterprises, respectively, being the SASAC and the central government departments, the local SASAC and the local government departments, the Chinese citizens on the Chinese Mainland, citizens from China’s Hong Kong SAR, Macao SAR and Taiwan, and foreign countries. And the enterprises actually controlled by these four categories of controllers can be referred to, respectively, as the central SOEs, the local SOEs, the private enterprises, and the overseas enterprises. As can be seen from Fig. 3.12, since 2003, the number of enterprises in the A-share market whose ultimate controllers are SASAC and the central government departments has shown a slow rise, while the number of enterprises controlled by the local SASACs and local government

Number of Enterprises

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1400 1200 1000 800 600 400 200 0

2003

2004

2005

Central SOE

2006

2007

2008

2009

Private Enterprises

Local SOE

2010

2011

2012

Foriegn-Funded Enterprises

The Sum of Total Asses of the Enterprises (yuan)

Fig. 3.12  Number of enterprises in various industries listed in the A-share market from 2003 to 2012. (Data source: Collated from the relevant data of CSMAR database) 1.6E+13 1.4E+13 1.2E+13 1E+13 8E+12 6E+12 4E+12 2E+12 0 2003

2004

Central SOE

2005

2006 Local SOE

2007

2008

2009

Private Enterprises

2010

2011

2012

Foreign- Funded Enterprise

Fig. 3.13  Sum of total assets of the enterprises in various industries listed in the A-share market from 2003 to 2012. (Data source: Collated from the relevant data of CSMAR database)

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departments has shown a slow decline. It goes to show that in the nationwide upsurge of local SOEs establishing “connectivity” with the central SOEs, the control rights of some local SOEs have indeed been transferred to the central SOEs. In addition, from 2003 to 2012, the number of private enterprises increased significantly, while the number of foreign enterprises did not change markedly. As is shown in Fig. 3.13, in the period of 2003 to 2006, the assets size of the central SOEs in the A-share listed companies was not as large as that of local SOEs. However, after 2006, the assets size of the central SOEs showed a growth spurt, and their assets size rapidly exceeded that of the local SOEs. It can be seen that the central SOEs have indeed achieved rapid expansion since 2003. 3.3.2  Transfer of Control Rights from Local SOEs to the Central SOEs: A Game Theoretic Model Analysis The control rights of local SOEs is generally in the hands of the local governments (or the local government departments), so the M&A of local SOEs often reflect the will of the local governments. Under the institutional background of China’s fiscal decentralization and political centralization, the local governments will compete for all kinds of tangible and intangible resources to fulfill the central government’s GDP-based economic performance evaluation index, thus forming competitions in all aspects (Zhou Li′an 2007). For local governments, the investment from the central SOEs is also a flow factor that can promote economic growth in their regions. Therefore, we believe that competition between local governments has prompted local governments to transfer control rights of local SOEs to the central SOEs. In the following, we will use a simple model of game between the local governments and the central SOEs to analyze the impact of local governments’ competition on the transfer of control rights of local SOEs. 3.3.2.1 Model Hypotheses (1) Basic Hypotheses Let us assume that an economy consists of one central SOE and n local SOEs. The n local SOEs are distributed in n homogeneous regions. The local government in each region controls only one local SOE, and there are no private enterprises or foreign-funded enterprises in the region. This means that the local government can only obtain the on-budget revenue

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from the local SOE, and the economic performance of the region depends only on the local SOE. Suppose the central SOE has the impulse to invest and expand and has sufficient capital.3 The central SOE invests in  local areas through M&A of local SOEs. And the amount of investment depends on the share of equity transferred by the local SOEs and the output (or profits) of local SOEs. The output of a local SOE is related to the investment it has obtained and the expenditure on the infrastructure construction in the region.4 (2) Maximization of Local Governments’ Utility For the local government, its utility lies in three aspects. The first is the performance of regional economic growth, because in the background of China’s decentralization system, there is the “promotion tournament” among local government officials in different regions (Zhou Li′an 2004), and Li and Zhou (2005) have confirmed that in China, the performance evaluation of local officials by the central government is mainly based on the relative growth rate of GDP, so the economic growth of the region will bring huge benefits to local government officials. The second is the level of social welfare in the region, which is mainly manifested in the supply of public goods. This assumption is also consistent with the previous studies of government objectives (see Qian and Roland 1998; Cai and Treisman 2005). The third aspect is the benefits of control obtained by the local governments from local SOEs. Zhang Weiying (1998) believes that the gain of an enterprise can be divided into tangible monetary gain and intangible non-monetary gain. This intangible non-monetary gain is the gain from control rights, which includes things like the gratification of commanding others, the on-the-job consumption that can be enjoyed, and the embezzlement of the enterprise resources. Bai Chong’en et  al. (2004a, b) have pointed out that local government officials can appoint or remove the top executives of local SOEs, so they can reap benefits from the SOEs; such benefits include arranging for their relatives, friends, and supporters to work in the SOEs, or transferring state-owned assets. In short, the local governments can gain control benefits from the local SOEs. We also assume that if the local government chooses to transfer the equity of the local SOE, then its benefits from the control rights will decrease with the reduction of the shareholding ratio, and even if the shareholding ratio decreases to the extent that the local government loses the control rights of the enterprise, the return on the control rights will still exist, though the return at this time will be very small.

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First of all, let us consider the situation that the local government does not transfer the equity of local SOEs, the utility function of the local government is:

Wi   f  ki ,I i   U  Ci   B



(3.12)

where Wi represents the utility of the local government in the ith region, α is the constant greater than 0, which stands for the weight the local governments (officials) give to the economic performance in the region, ki stands for the amount invested in the local SOEs, Ii is the expenditure on infrastructure construction,5 f(ki, Ii) represents the output of the local SOE, Ci is the expenditure on public goods, U(⋅) is the total utility function of residents’ expenditure on public goods, B stands for the control rights benefits the local government can gain from the local SOE. In the equation, the output function f(ki, Ii) satisfies the presupposition f1(ki, Ii) > 0, f2(ki, Ii) > 0, f11(ki, Ii)  0, U ″(⋅)  2B/αe when it is 1: T

1

 1    2

2



2B e

(3.27)

This condition in (3.27) can ensure the establishment of tib = 1. A step further, we can combine the two constraints in (3.23) and work out the optimal amount of investment from the central SOE into the local SOE and the optimal expenditure on public goods, and reach the optimal solution for the problem:



tib  1   k b  1  e   2 T  1  i 4 4 2  1  I ib  T  2 2   e     1  b 2 Ci  2  e    

(3.28)

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For this optimal solution, the utility the local government can gain is: 1 1 Wi b   f kib ,I ib  U Cib  1  tib B    e    T  (3.29) 2 2  e   







  



When 1/2αeIi − B  0, the greater Mi is, the greater the return the local government can reap from the transference of the equity of the local SOE, and the stronger the motivation the local government has for the transfer. On the contrary, the less Mi is, the weaker the motivation the local government has for the transfer of the equity. When Mi  0, Wi b will increase with the increase of β, and hence Mi will increase with the increase of β. When β = 0, according to (3.32), we get:

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Mi 

1 1  e  1   T    B 2  e 

(3.34)

Because T  >  1/(αe)2, αT  −  1/(αe)  >  1/(αe2)  −  1/(αe)  =  (1/e  −  1)/ (αe) > 0. And also because e − 1