Formal Contracts and Institutional Norms in the Chinese Business Environment: An Empirical Investigation of the Manufacturing Sector

Inter-firm contractual arrangements characteristically form the back-bone of a business relationship, and are facilitated by a mix of informal and formal governance structures. In the lead-up to and post WTO accession, the Chinese government implemented wide-ranging reforms to its business environment. As a result, the use of inter-firm contracts as a business norm has been influenced by legislative and policy-based changes to the formal institutional structure as well as the dynamic behaviour of informal business norms. The aim of this paper is to investigate the prevalence of formal contractual arrangements used by firms after two key events; the legislation of a new Contract Law and China’s WTO membership. In particular, to facilitate this investigation, this paper will focus on the Chinese manufacturing sector and utilise a World Bank Investment Climate survey from 2003 in order to analyse four key elements that comprise many business relationships and influence inter-firm contractual behaviour, namely: the spatial distance between firms conducting business with one another, the use of trade credit, the presence of switching costs, and the market power of firms relative to their suppliers and customers. This paper finds that these four elements, given the prevailing institutional framework governing the Chinese business environment, do lead to a propensity for firms to engage in formal contractual arrangements. The overall implications of these results are far less explicit given the limited scope of the empirical analysis and the data set used. However, the results do indicate further and more thorough research is warranted, especially considering China’s role on the global business stage