Institutions and Corporate Investment: Evidence from Investment-Implied Return on Capital in China

Abstract We assess the impact of institutions on Chinese firms’ corporate investment in an investment Euler equation framework. We allow the variables measuring institutions to affect the rate at which firm managers discount future investment payoffs. Applying generalized method of moments estimators to large samples of Chinese firms, we estimate the stochastic discount rates derived from actual investment and examine how they vary across institutional variables. We document robust evidence that ownership is the primary institutional factor affecting corporate investment in China. The derived discount rate for a nonstate firm is approximately 10 percentage points higher than that of an otherwise equal state firm. State firms tend to use higher discount rates to invest after they are partially privatized. We also find that firms with higher levels of corporate governance use higher discount rates to make investment.