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The existing studies have failed to find conclusive results on the relative importance of property rights protection and access to external finance for enterprise reinvestment partly due to their lack of control for the endogeneity problems. In this study, using data of China's private enterprises, we re-investigate this issue by carefully addressing the endogeneity issues. We find that property rights protection is more important for the reinvestment decision than the access to external finance. Our study demonstrates forcefully that, China is no different from other transition economies regarding the fundamental importance of property rights security to firm performance.
Key Words: Property rights protection; Access to external finance; Reinvestment decision; China economy.
JEL Classification Numbers: P14, G34, L25, D23.
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1.INTRODUCTION
Recently a large body of studies demonstrates the importance of property rights protection for firm performance and economic growth.1 Meanwhile, there is another line of research showing that financial sector development and hence firms' access to external finance is also important for economic performance and growth.2 An intellectually intriguing question then is which of these two types of institutions is relatively more important. The answer to this question would also have implications for policy recommendations, especially for developing economies that strive to grow under imperfect institutions.
There are two existing studies examining the relative importance of property rights protection and access to external finance for transition and developing economies. Using data from Poland, Romania, Russia, Slovakia, and Ukraine, Johnson, McMillan, and Woodruff (2002) find that property rights protection is relatively more important than access to external finance for firms' profit reinvestment decision. However, using data from a World Bank survey of China's enterprises, Cull and Xu (2005) show that access to external finance is as important as property rights protection for firms' reinvestment decision. They argue that this difference stems from the stronger complementarity between internal and external finance in China; in addition, with the progress in transition in China in the early 2000s, supporting institutions including financial institutions become increasingly important for firm growth.
The conflicting and inconclusive results of the above two studies raise the question whether China really differs from other transition economies in terms of the relative importance of property rights protection and financial development. In...