Incentive Contracting versus Ownership Reforms: Evidence from China's Township and Village Enterprises

Abstract

We use a unique data set to study the implications of introducing managerial incentives and, in addition to incentives, better defined ownership for a firm's financial performance. The data set traces the ten-year history of 80 Chinese rural enterprises, known as township and village enterprises. During this period, these originally (mostly) community owned, local government controlled socialist collective firms were first allowed to introduce managerial incentive contracts and then to change to ownership forms of more clearly defined income and control rights. The study finds that introducing managerial incentives had a positive but statistically insignificant effect on these firms' performance measured by accounting return on assets or return on equity. It also finds that the performance is significantly better under ownership forms of better-defined rights than under community ownership even when the latter is supplemented with managerial incentive contracts. The findings shed lights on some important theoretical and policy issues.