Can Two Wrongs Make a Right? State Ownership and Debt in a Transition Economy

abstract Existing literature suggests that both state ownership and debt have detrimental performance consequences in transition economies. Paradoxically, however, we contend that the confluence of these two conditions may not be harmful. By considering the interactions between the governance properties of state ownership and debt, interpreted in light of the institutional context of China (i.e. the interplay between local governments, managers, and central banks), we argue that state ownership and debt can potentially offset each other's detrimental effects. We test our hypotheses with a sample of over 1300 Chinese firms that were listed on the Shanghai and Shenzhen Stock exchanges between 2003 and 2005. Results of the tests confirm that while debt and state ownership each have a negative impact on firm performance when used in isolation, their interaction has a positive impact on firm performance.