Essays on corporate governance in China's transition to market economy: A study of the Township-Village Enterprise (TVE) sector

This thesis consists of three essays. The first essay examines the privatization of rural China's Township-Village Enterprises (TVEs) since the mid-1990s. Based on the existing empirical study, the TVE sector's privatization turns out to be dominated by a special privatization program, management buy-out (MBO), which can be characterized as a situation where the incumbent manager/buyer may hold private information on his own valuation of the firm and the local official/seller may offer discounted buy-out price in exchange for bribe from the manager. To formalize the situation, a hybrid model of adverse selection and moral hazard is developed. A buy-out contract in the model includes not only buy-out price but, more importantly, bribe as an implicit part. Normative analysis shows that corruption brings insufficient ex-post managerial incentives and suboptimal managerial effort level, which implies that, in the presence of corruption, privatization may not necessarily improve firm's performance. Positive study shows that such two part price-bribe contracts can be used to form a screening mechanism to elicit private information from the manager. Moreover, the model predicts that post-privatization profit level increases with buy-out price and a more profitable firm is less subject to corruption. The second essay serves as an extension of the model developed in the first essay. The essay presents the theory of MBO in a continuous type formulation. It turns out that the continuous version of the model can replicate most of the results produced by the first essay. Moreover, the essay also considers an alternative timing formulation of the model. The positive relationship between the buy-out price and ex-post profit level proves to be robust to different approaches to the timing of the model. The existing TVE literature has been concentrated on the TVEs that are fully owned by local governments. However, little research attention has been given to another specific ownership arrangement in the TVE sector: joint ownership between local entrepreneurs and governments. The third essay examines those joint ownership TVEs. The essay first provides evidence to characterize the imperfect financial markets in China's transition to market economy. The private sector turns out to be subject to a considerable amount of financial discrimination in the markets. Second, a model is provided to formalize how joint ownership is chosen by local entrepreneurs as opposed to private ownership. This model implies that under certain market environments, such as an underdeveloped credit market, joint ownership may arise as equilibrium. Moreover, welfare analysis shows that joint ownership, at equilibrium, is more efficient than private ownership