A Tale of Two Provinces: The Institutional Environment and Foreign Ownership in China

Abstract

In this paper, we use a unique dataset covering joint ventures in two provinces of China, Jiangsu and Zhejiang, to test the effect of the institutional environment for domestic private firms on ownership structures of FDI projects. Unlike many studies on this subject, we approach the issue from the perspective of local firms seeking FDI rather than from the perspective of foreign firms seeking to invest in China. Applying the prevailing bargaining framework in studies on ownership structures of FDI projects, we find that a more liberal institutional environment for domestic private firms is associated with less foreign ownership of the joint ventures operating there. Several mechanisms can contribute to this outcome. One is that a more liberal institutional environment may enhance the bargaining power of those domestic firms negotiating with foreign firms to form alliances (the capability effect). The other mechanism is that a more liberal institutional environment may reduce some of the auxiliary benefits associated with FDI - such as greater property rights granted to foreign investors - and thereby attenuate incentive to form alliances with foreign firms (the incentive effect).