Foreign direct investment concessions and environmental levies in China

FINANA-00658; No of Pages 10 International Review of Financial Analysis xxx (2013) xxx–xxx

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International Review of Financial Analysis

Foreign direct investment concessions and environmental levies in China Qiu Chen a,1, Min Maung b,2, Yulin Shi c,3, Craig Wilson b,⁎ a b c

Sprott School of Business, Carleton University, Ottawa, Ontario K1S 5B6, Canada Edwards School of Business, University of Saskatchewan, Saskatoon, Saskatchewan S7N 5A7, Canada Asper School of Business, University of Manitoba, Winnipeg, Manitoba R3T 2N2, Canada

a r t i c l e

i n f o

Available online xxxx JEL classification: F18 F23 G32 Keywords: FDI Subnational concessions Pollution fees Provincial development Private equity Entrepreneurial firms

a b s t r a c t We investigate how foreign involvement in the ownership of privately held entrepreneurial firms affects pollution fees levied by national and provincial governments in China (environmental levies). Because provincial governments have considerable control over environmental policies, differences in environmental levies provide a good proxy for measuring provincial concessions made for the purpose of attracting investment, and particularly foreign direct investment (FDI). Furthermore, because we consider privately held entrepreneurial firms rather than publically listed firms, foreign involvement in ownership provides a good proxy for FDI. We find that firms with foreign ownership do indeed pay lower environmental levies, which indicates that concessions are made to attract FDI to China. However, these concessions are conditional on the level of development of the province offering them, with better developed provinces providing fewer concessions for FDI. We also find that greater concessions are made to foreign joint venture firms having a foreign ownership stake of less than or equal to 50%. © 2013 Elsevier Inc. All rights reserved.

1. Introduction Private enterprise has been the engine of economic growth around the world in both developed and emerging economies (Ball & Shivakumar, 2005). Within the private sector, the role played by privately held entrepreneurial firms is especially crucial. For example, in China such entrepreneurial firms account for over 60% of GDP and 80% of employment (Chen, Ding, & Wu, 2013). Entrepreneurial firms are relatively small, young, and growing firms that take risks to explore business opportunities (Markman & Baron, 2002; Shane, 2000). As such, these firms often face capital constraints, especially in emerging markets such as China, because they have limited access to local capital markets. To alleviate capital constraints, some domestic firms attract foreign capital to found joint ventures or wholly foreign-owned enterprises, so foreign direct investment (FDI) can be an important source of entrepreneurial financing. We investigate how foreign capital involvement in Chinese privately held entrepreneurial firms affects provincial concessions in the form of reduced environmental levies.4 ⁎ Corresponding author. Tel.: +1 306 966 8430. E-mail addresses: [email protected] (Q. Chen), [email protected] (M. Maung), [email protected] (Y. Shi), [email protected] (C. Wilson). 1 Tel.: +1 613 520 2600x1874. 2 Tel.: +1 306 966 2829. 3 Tel.: +1 204 474 6752. 4 Note that environmental levies are a fee on the pollution output of a firm payable to the government. While from an accounting perspective they differ from a tax (hence we use the term levy), from an economic perspective they have a similar effect, and therefore concessions on environmental levies could affect FDI similarly to other tax concessions.

FDI can be an important source of capital for promoting economic development and entrepreneurial activities. Not only does it provide a significant economic impact on countries and firms that receive investment (Sun, 1998), but also affects the investors of FDI companies (Ding & Sun, 1997). From the perspective of foreign firms, the decision to invest is determined by the risk-adjusted return on their investment, which in turn is determined by both firm and host-country or regional characteristics at the time of the investment decision. In particular, both country and location-specific characteristics may directly or indirectly influence the decision to invest. For instance, multinational corporations (MNCs) are mainly attracted by strong fundamentals such as market size, availability of skilled labor, and availability of infrastructure (Blomström & Kokko, 2003; Blonigen, 2005). Using a detailed analysis of data from 164 countries, Buchanan, Le, and Rishi (2012) find that a country's institutional environment can strongly affect FDI. However, apart from country-level characteristics, which are generally systematic in nature and are usually beyond the control of individual firms, incentives and concessions provided by host country governments also play an important role in affecting a foreign firm's decision to invest in a country or in a specific location (Blomström & Kokko, 2003). The United Nations Conference on Trade and Development (1996) (UNCTAD hereafter) reports various incentives and concessions that host countries might offer to attract FDI. These concessions come in many forms such as tax incentives, subsidies, grants, and preferential loans. One of the most widely studied aspects of host country concessions given to MNCs is tax incentives. Rather than imposing encompassing low statutory tax rates, it is often more effective for host country governments to offer selective tax incentives, which have a smaller negative impact on fiscal revenue. Selective tax incentives may also serve

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Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

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as a signal of the host country's commitment to attracting FDI, and are often easier to implement than a general reform of the tax system (Bond & Samuelson, 1986). Even regional differences in tax incentives can play an important role in affecting a foreign firm's decision to invest in a particular location. For instance, Coughlin, Terza, and Arromdee (1991) contend that higher state taxes deter FDI in the U.S. Similarly, Hines (1996) reports that state taxes influence the pattern of foreign investment in the U.S. Most of the academic research on concessions and incentives focus on country-level characteristics rather than regional characteristics. There are two main drawbacks associated with this broader countrylevel focus: First, do firms actually realize tax concessions associated with national incentives ex post? Second, do regional incentives amplify or offset national concessions? We address both of these concerns. We use the ex post fees levied on environmental pollution (environmental levies) as a firm-level proxy for concessions to test whether foreign capital investment actually results in lower levies. Furthermore, by considering provincial effects for the single country China, we avoid the usual problems that affect cross-country studies related to decomposing natural competitive advantages such as political, cultural, and other institutional effects, accounting standards, and other country-level effects, from concessions, as well as the difficulty of simply measuring concessions consistently across countries. While there are clearly differences among provinces, these effects are much less pronounced than they are among different countries. Thus far, we have used the term FDI loosely. Before proceeding further, it is useful to define it formally. UNCTAD defines FDI as “investment made to acquire lasting interest in enterprises operating outside of the economy of the investor.” FDI is different from usual portfolio capital inflows (generally known as “hot” money) in the sense that it is a “direct investment” in the local firms with the investors intending to gain an active voice and some degree of control. We consider private firms with no liquid secondary equity markets, so these firms are prime examples of direct investment. We predict that firms with foreign capital involvement in China should enjoy favorable treatment from local, provincial governments in the form of lower environmental levies. However, we also expect that entrepreneurial firms in better developed provinces have less need for foreign capital, and therefore concessions in the form of lower environmental levies provided to encourage foreign involvement should be lower for better developed provinces. In other words, the interaction between foreign involvement and provincial development should positively affect environmental levies. We also anticipate that provincial governments will treat FDI investments more favorably when they are made jointly with local investors. These joint ventures can provide a number of benefits beyond investment and employment opportunities, such as technology and knowledge transfer, and allow local firms to participate in future growth opportunities. We test our hypotheses by using an official source of data provided by the National Bureau of Statistics of China. One important source of value of this data set is that it provides proprietary information for a large set of privately held entrepreneurial firms that would otherwise be difficult to obtain.5 Our results confirm that environmental levies are one aspect of concessions provinces make to attract FDI to China. In general, we find that foreign investment reduces the environmental levies charged to firms. While concessions generally increase with the

ownership percentage, other factors might also be important for firms in which foreign ownership is dominant. We control for a number of provincial and firm specific factors that could also affect environmental levies, and our findings are consistent. We also find that the degree of provincial development mitigates the concessions given to foreign ownership. Better developed provinces tend to provide fewer concessions to firms with foreign ownership. These regional differences are consistent with prior studies documenting the existence of a domestic firm pollution haven in China (Di, 2007; Jiang, Lin, & Lin, 2013; Lu, Wu, & Yu, 2012). On the other hand, Dean, Lovely, and Wang (2009) show that at least some foreign investors are attracted to Chinese provinces with weak environmental standards; our finding of the existence of environmental levy concessions provides one explanation to such behavior. It is worth noting that recent studies present mixed evidence on the impact of foreign firms on environmental pollution. Jiang et al. (in press) show that foreign firms in China tend to pollute less compared to state-owned enterprises, ceteris paribus, and Kirkulak, Qiu, and Yin (2011) find that the presence of FDI in China has no negative impact on the air quality. In contrast, Cole, Elliott, and Zhang (2011) find that foreign firms have a detrimental effect on environmental emissions in China in several cases, such as petroleum-like matter, waste gas, and SO2. We find that foreign firms still receive concessions even after taking into consideration the possibility that they may pollute the environment less intensively than local firms. Our results provide practical guidance to foreign firms that are considering making a direct investment in China. The decision about where to locate in China is complex, and provincial differences in environmental regulation and enforcement add to this complexity. Although our findings suggest that FDI is more likely to flow into regions with higher concessions, Dong and Torgler (2010) show that less developed provinces in China are also more corrupt, which deters foreign investors from entering these regions. As a result, the location choice requires a systematic consideration of both benefits and costs. Our findings also have policy implications for China. One aspect of the decentralization of environmental regulations is that provincial governments have a greater ability to provide concessions to foreign-owned firms for the purposes of attracting FDI, which could give foreign-owned firms a competitive advantage over purely domestic firms. This problem is exacerbated by the incentive system and opportunities for advancement associated with economic growth, particularly since pollution is largely a public (national and even international) cost. Together, the opportunity and incentive could lead provincial governments to compete with each other to weaken environmental standards for the purpose of attracting FDI. As such, there could be a role for the central government to limit the opportunity (by developing more comprehensive national standards) or the incentive (through political reform). The remainder of this article is organized as follows. Section 2 examines the previous literature and develops hypotheses. Section 3 describes the data and methodology used to investigate our research questions. Section 4 discusses and analyzes the empirical results. Section 5 concludes and considers implications of the findings.

2. Previous literature and hypothesis development 2.1. Environmental levies charged in China

5 Jiang, Adams, and Jia-Upreti (2012) examine how managerial entrenchment affects the use of insurance in Chinese firms; however, they use survey data and a mix of both listed and private companies. Our employment of accounting information from purely private companies allows more accurate tests for our hypotheses, as survey data may be biased, and listed companies face different incentives and regulation in environmental control.

Environmental pollution is a serious concern in most jurisdictions, including China. China's main technique for managing pollution is a pollution levy system, in which a per unit fee is levied on specific forms of pollution (Dean et al., 2009; Wang & Wheeler, 2003). In this way firms are required to compensate for their negative environmental impact. Despite the simple nature of this process, its implementation can be very complex. For instance, 61 pollutants were identified as sources of

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

Q. Chen et al. / International Review of Financial Analysis xxx (2013) xxx–xxx

water pollution, and for each pollutant the extent of its pollution is estimated and a fee is charged at a specified rate.6 Both central and provincial governments are involved in the process of law making, but as Wang et al. (2002) point out, provincial governments play a dominant role in the environmental levy system. Ding, Jia, Wu, and Yuan (2012) provide three reasons why the authority of implementing environmental regulations and levies is delegated to local governments. First, due to geographical differences across China and the distribution of industries in different regions, the main types of pollutants vary between provinces. The central government only regulates certain types of pollutants, and leaves others, such as water pollution, to provincial governments. Second, provincial governments in China also have the authority to establish their own regulations. Local governments can set up regulations when the central government does not provide any, and they can require more stringent regulations than those already established by the central government. Third, provincial governments are mainly responsible for enforcing regulations, so they ultimately decide on the actual implementation, which can even result in some provinces having a less stringent application of standards than the minimum required by the central government (Wang & Wheeler, 2005). Therefore, provincial governments have considerable discrepancy over the environmental fees levied on firms operating in their respective provinces. 2.2. Hypothesis development All else being equal, provincial governments are likely to provide concessions in the form of reduced environmental levies to firms with foreign involvement. On the one hand, it is a common practice in China that firms with foreign involvement receive favorable treatment, as foreign investment generates a positive spillover leading to increased GDP, employment, and technological improvement (Chen et al., in press), and these spillover effects are important to local bureaucrats for political promotion (Park, Li, & Tse, 2006). As a result, it is not uncommon for provincial governments to provide financial incentives, such as tax breaks, and non-financial incentives, such as simplified approval processes and preferential access to land, to attract foreign investment (Brewer & Young, 1997). The early success stories of some coastal provinces, such as Guang Dong province, are mainly driven by foreign capital investment (Zheng, 2012), which could lead other provincial governments to believe that foreign investment is a key factor for provincial development, possibly resulting in provincial governments competing with each other to offer more incentives in order to attract foreign investment. For example, Wei, Liu, Parker, and Vaidya (1999) find that preferential policies offered by Chinese provinces are one of the key determinants for the distribution of FDI across regions in China. On the other hand, foreign firms have bargaining power to negotiate favorable treatment with central or local governments (Ding et al., 2012; Kobrin, 1987; Nebus & Rufin, 2010). Compared to domestic firms, firms with foreign capital involvement often have proprietary knowledge, industry status, distribution networks, and a favorable perception by customers in emerging markets (Chen et al., in press; Ding et al., 2012; Insch & Miller, 2005; Sharma, 2011). These advantages give foreign firms power to negotiate reduced environmental levies with local governments (Ding et al., 2012). For these reasons, firms 6 No 31 Order of State Development Planning Commission of the People's Republic of China (now named the National Development and Reform commission), Ministry of Finance of the People's Republic of China, State Environmental Protection Administration of the People's Republic of China (now named the Ministry of Environmental Protection of the People's Republic of China ), and the State Economic and Trade Commission of the People's Republic of China (now named the Ministry of Commerce of the People's Republic of China) “Measures for the Administration of the Charging Rates for Pollutant Discharge Fees,” which is enacted in accordance with the “Regulations on the Administration of the Charging and Use of Pollutant Discharge Fees” can be found on the provincial government website, http://www.hbepb.gov.cn/hbfg/hbbgz/200411/t20041112_8749.html.

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with foreign involvement are expected to pay lower environmental levies, ceteris paribus. Hypothesis 1. Environmental levies are negatively associated with foreign involvement. The imbalance of economic development in different regions in China is well documented (Fan, Wang, & Zhu, 2007). Provincial differences in economic development could lead provinces to adopt different strategies for dealing with pollution. Provincial leaders are motivated to facilitate economic development, because it is a key indicator of performance that can affect the potential for political promotion (Li & Zhou, 2005; Park et al., 2006). Furthermore, environmental law established by the central government regulates the fundamentals of environmental protection, and only determines the minimum requirement of the levy standards (Ding et al., 2012). As a result, provinces and regions are allowed and even encouraged to set up their own standards that are applicable to local markets. This flexibility provides provincial governments with the authority to take actions that are in the best interests of the local citizens, whether that be a focus on environmental protection or economic development. It is reported in the Chinese media that in some cities heavily polluting plants are launched to boost local economies and employment, while in other places such investments are not welcome.7 In sum, different provincial incentives arising from disproportionate economic development, in conjunction with the authority and flexibility granted to local governments, make environmental regulation in general and environmental levies in particular quite heterogeneous across the nation, thus providing an opportunity for investors to compare locations, and provinces to provide greater or fewer concessions to attract investment in general and FDI in particular. Authorities in less developed provinces could be concerned that strict enforcement of environmental regulations may jeopardize economic development, and as a result they may install lenient enforcement standards in order to keep or attract investment (Zhang, Vertinsky, Ursacki, & Nemetz, 1999). Authorities in more developed provinces may feel less pressure to sacrifice environmental protection in order to increase economic development. As noted in Wang and Wheeler (1996), the 1993 water pollution levy charged in Tianjin was eight times higher than in Qinghai. In general, better developed provinces tend to have more stringent environmental protection regulations (Dean et al., 2009; Wang & Wheeler, 2003). Tighter pollution controls, results in less polluting (Jiang et al., in press), so we expect lower levies for better developed provinces. This discussion leads to our second hypothesis. Hypothesis 2. Environmental levies are negatively associated with provincial development. Our third hypothesis extends the previous two. Better developed provinces have a lesser need to attract FDI, since domestic firms in better developed provinces are better able to meet their own investment needs than domestic firms in lesser developed provinces. Furthermore, better developed provinces could be more concerned with the quality of FDI, and better technology is associated with greater efficiency and less pollution. Finally, due to better infrastructure, these provinces might also be in a better position to negotiate and refrain from providing concessions. While foreign involvement in general should reduce the amount of environmental levies paid, we expect the degree of provincial development to mitigate some of this effect. Thus, better provincial development should moderate the negative association between foreign involvement and environmental levies. 7 Heavily polluting industries move from economically developed provinces to less developed provinces and rural regions in China. This article is reported in the newspaper: Shenzhen Special Zone Daily on 2008/03/07, A8–A9. http://sztqb.sznews.com/html/ 2008-03/07/content_86662.htm. This article can also be found on Sina News: http:// news.sina.com.cn/c/2006-02-13/10448192737s.shtml.

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

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Hypothesis 3. Environmental levies are positively associated with the interaction between foreign involvement and provincial development. 3. Data and methodology In 2004, all industrial firms in mainland China were required to file their pollution levies, along with detailed accounting and ownership information, to the National Bureau of Statistics of China. From this information, the GTA Information Technology Co. compiled the Chinese Non-Listed Enterprise Database (CNED). The CNED is used in prior literature (Chang & Xu, 2008; Chen et al., in press; Ding et al., 2012; Park et al., 2006), and presents a valuable opportunity to study privately held enterprises in China, as detailed firm-level information for private firms is difficult to obtain from other sources. Following Ding et al. (2012), in addition to CNED data we retrieve other relevant information, such as GDP and information needed to compute enforcement strictness, from the Annals of Statistics in China, and we use information published by the National Economic Research Institute (NERI) to capture provincial economic development (Fan et al., 2007). 3.1. Variables The variables we use are summarized in Table 1. 3.1.1. Environmental levies Our dependent variable, ENVLEVY, is calculated as the environmental levies paid by a firm in 2004 scaled by total assets. One form of concession a province could make is to levy a lower amount of pollution fees on a firm, so ENVLEVY should be negatively associated with concessions. 3.1.2. Foreign involvement One of our main independent variables is foreign involvement, which, in the context of the private entrepreneurial firms we consider, is related to FDI. To be consistent with prior literature (Chen et al., in press; Ding et al., 2012), foreign involvement includes investment from foreign countries, including Hong Kong, Macau, and Taiwan. We use four variables to capture the effect of foreign involvement: FOROWN is a continuous variable measuring the proportion of ownership held by foreign investors, based on the book value of equity. FOROWNDUM is a dummy variable indicating foreign ownership such that it equals one if a firm has foreign ownership greater than zero,

3.1.3. Provincial development Our second main independent variable is provincial development. We use two variables to characterize the level of economic development for each province in China: MARKETIZATION is an index developed from 23 indicators in 5 key areas related to provincial economic development (Fan et al., 2007), and has been used to measure the imbalance of economic conditions across China (Chen et al., in press). Higher values of MARKETIZATION indicate a greater degree of economic development. PROVGDP is the per capita gross domestic product for each province measured in units of 1000 RMB. 3.1.4. Control variables Following Ding et al. (2012) and Chen et al. (in press), we adopt a variety of variables to control for their effects on the amount of levies paid. Three variables are related to environmental regulation and enforcement. POLFINE measures the total amount of fines paid by all firms in a province for pollution accidents measured in units of 100,000 RMB. The variable STRICTNESS measures the enforcement strictness of environmental protection, and is calculated following Ding et al. (2012).8 It reflects the intensity of environmental control in four key aspects: waste water, smoke, soot, and sulfur dioxide. POLINV captures the total amount of investment made by all firms in a province to control pollution measured in units of 100,000,000 RMB. Net income (NI), defined as net income scaled by assets, is used to capture profitability. LIQUIDITY measures the current ratio, calculated as current assets divided by current liabilities, CAPINT uses total assets divided by total revenue to capture capital intensity, LNTA is a proxy for firm size, calculated as the natural logarithm of total assets (measured in units of 1,000 RMB), and LNAGE is the natural logarithm of a firm's age in years since its inception. We also control for industry fixed effects. To exclude any potential outliers, we winsorize all variables at 1% and 99%.9 3.2. Model specification We use Eq. (1) to estimate the direct effects of foreign ownership and provincial development on pollution levies paid by firms, as well as the interactive effect of foreign ownership and provincial development: ENVLEVY ¼ a0 þ a1 FORINV þ a2 PROVDEV þ a3 FORINV  PROVDEV þa4 CONTROLS þ ε;

Table 1 Variable definitions. ENVLEVY FOROWN FOROWNDUM FORJVDUM

and zero otherwise. FORJVDUM is a dummy variable indicating a minority or equal control, such that it equals one if a firm has foreign ownership greater than zero, but less than or equal to 50%. FORCTRLDUM is a dummy variable indicating foreign control such that it equals one if a firm has foreign ownership greater than 50%, and zero otherwise. Data on the proportion of foreign ownership are obtained from CNED.

Firm level Firm level Firm level Firm level

FORCTRLDUM Firm level MARKETIZATION Provincial PROVGDP

Provincial

POLFINE

Provincial

STRICTNESS POLINV

Provincial Provincial

NI LIQUIDITY CAPINT LNTA LNAGE

Firm level Firm level Firm level Firm level Firm level

Environmental levy/total assets Foreign equity/total equity Dummy variable indicating FOROWN N 0 Dummy variable indicating FOROWN N 0 and FOROWN ≤ 50% Dummy variable indicating FOROWN N 50% Provincial market development index (Fan et al., 2007) Provincial GDP/provincial population (units = 1,000 RMB per capita) Provincial total pollution fines (units = 100,000 RMB) Pollution regulation strictness (Ding et al., 2012) Provincial total pollution investment (units = 100,000,000 RMB) Net income/total assets Current assets/current liabilities Total assets/total revenue Ln(total assets) (units of total assets = 1,000 RMB) Ln(firm age) (units of age = years)

ð1Þ

where ENVLEVY is the dependent variable measuring the amount of levies paid by each firm.10 FORINV indicates foreign involvement, and is measured by the four variables: FOROWN, FOROWNDUM, FORJVDUM, and FORCTRLDUM. PROVDEV captures different levels of economic development across provinces, and is measured using two variables: MAKETIZATION and PROVGDP. CONTROLS refer to other control variables including POLFINE, STRICTNESS, and POLINV to capture factors related to provincial environmental regulations and enforcement, as well as the firm level variables NI, LIQUIDITY, CAPINT, LNTA, LNAGE, and industry fixed effects. The coefficients of the foreign involvement measures are expected to be negative. We also expect the measures of provincial

8

We thank Zhenyu Wu for providing the data on this variable. For robustness, we also winsorize the variables at 5% and 95%, and the results are consistent. 10 For completeness, we also investigate the model without the interaction terms. 9

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

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Table 2 Descriptive statistics of the full sample. This table presents the summary statistics for privately held companies in China reported in the CNED in 2004. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FOROWN, FOROWNDUM, FORJVDUM, and FORCTRLDUM are four foreign ownership variables to identify foreign investor involvement. FOROWN is a continuous variable, defined as the book value equity percentage owned by foreign investors. FOROWNDUM, FORJVDUM, and FORCTRLDUM are dummy variables equal to 1 when firms have foreign investors, when foreign investors have less than or equal to 50%, and when foreign investors control more than 50% of total book equity, 0 otherwise. MARKETIZATION and PROVGDP are proxies for provincial development. MARKETIZATION is an index developed using 23 indicators in 5 key areas of provincial economic development. PROVGDP is the provincial GDP per capita in thousands of RMB. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. Variable

Obs.

Mean

Std Dev

Minimum

Maximum

ENVLEVY FOROWN FOROWNDUM FORJVDUM FORCTRLDUM MARKETIZATION PROVGDP POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE

79871 79531 79531 79531 79271 78778 78778 76935 78755 78778 79870 78900 79858 79871 79863

0.002 0.140 0.187 0.055 0.132 7.659 16.523 1.107 3.403 1.103 0.063 1.584 1.199 9.979 1.816

0.005 0.323 0.390 0.228 0.339 1.730 7.364 1.725 0.504 0.368 0.135 2.312 1.309 1.517 1.065

1.47E-05 0 0 0 0 1.55 4.078 0.027 1.453 0.24 −0.167 0.098 0.093 7.186 0

0.032 1 1 1 1 9.81 40.601 8.692 3.983 3.93 0.754 17.800 8.037 14.580 3.970

development to have negative association with ENVLEVY. However, the coefficients of the interaction terms between the foreign involvement measures and provincial development measures are expected to be positive.

4. Results Table 2 presents the descriptive statistics. In our sample of over 79,000 private firms, foreign equity ownership ranges from 0 to 100%,

Table 3 Descriptive statistics by subsample. This table presents the summary statistics for different groups based on foreign ownership. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FOROWN, FOROWNDUM, FORJVDUM, and FORCTRLDUM are four foreign ownership variables to identify foreign investor involvement. FOROWN is a continuous variable, defined as the book value equity percentage owned by foreign investors. FOROWNDUM, FORJVDUM, and FORCTRLDUM are dummy variables equal to 1 when firms have foreign investors, when foreign investors have less than or equal to 50%, and when foreign investors control more than 50% of total book equity, 0 otherwise. MARKETIZATION and PROVGDP are proxies for provincial development. MARKETIZATION is an index developed using 23 indicators in 5 key areas of provincial economic development. PROVGDP is the provincial GDP per capita in thousands of RMB. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. 0

(0, 100%]

(0, 50%]

(50%, 100%]

Variable

Mean (S.D)

Mean (S.D)

Mean (S.D)

Mean (S.D)

ENVLEVY

0.003 (0.005) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 0.000 (0.000) 7.462 (1.756) 15.924 (7.326) 1.192 (1.797) 3.387 (0.525) 1.121 (0.371) 0.067 (0.139) 1.496 (2.156) 1.190 (1.336) 9.849 (1.496) 1.830 (1.110)

0.001 (0.004) 0.751 (0.314) 1.000 (0.000) 0.294 (0.456) 0.718 (0.450) 8.539 (1.270) 19.203 (6.927) 0.749 (1.334) 3.479 (0.390) 1.028 (0.343) 0.048 (0.118) 1.974 (2.865) 1.227 (1.171) 10.534 (1.468) 1.746 (0.831)

0.001 (0.003) 0.310 (0.116) 1.000 (0.000) 1.000 (0.000) 0.000 (0.000) 8.180 (1.478) 18.800 (6.965) 1.089 (1.782) 3.571 (0.397) 1.178 (0.349) 0.058 (0.112) 1.589 (2.100) 1.248 (1.232) 10.736 (1.567) 1.784 (0.885)

0.002 (0.0040) 0.935 (0.138) 1.000 (0.000) 0.000 (0.000) 1.000 (0.000) 8.688 (1.141) 19.370 (6.904) 0.610 (1.066) 3.440 (0.381) 0.966 (0.321) 0.044 (0.120) 2.135 (3.117) 1.219 (1.145) 10.450 (1.417) 1.731 (0.807)

FOROWN FOROWNDUM FORJVDUM FORCTRLDUM MARKETIZATION PROVGDP POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

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Table 4 Correlations. This table presents the Pearson correlation coefficients of the pairwise variables among environmental levies, foreign involvement, provincial development, environmental enforcement, and firm-level characteristics. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FOROWN, FOROWNDUM, and FORCTRLDUM are three foreign ownership variables to identify foreign investor involvement. FOROWN is a continuous variable, defined as the book value equity percentage owned by foreign investors. FOROWNDUM and FORCTRLDUM are dummy variables equal to 1 when firms have foreign investors and when foreign investors control more than 50% of total book equity, 0 otherwise. MARKETIZATION and PROVGDP are proxies for provincial development. MARKETIZATION is an index developed using 23 indicators in 5 key areas of provincial economic development. PROVGDP is the provincial GDP per capita in thousands of RMB. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. Variable

ENVLEVY

FOROWN

FOROWN-DUM

FORCTRL-DUM

MARKETI-ZATION

ENVLEVY FOROWN FOROWNDUM FORCTRLDUM MARKETIZATION PROVGDP POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE

1 −0.075⁎⁎⁎ −0.087⁎⁎⁎ −0.067⁎⁎⁎ −0.048⁎⁎⁎ −0.070⁎⁎⁎ 0.017⁎⁎⁎ −0.036⁎⁎⁎ −0.039⁎⁎⁎ 0.189⁎⁎⁎ 0.030⁎⁎⁎ −0.177⁎⁎⁎ −0.257⁎⁎⁎ −0.094⁎⁎⁎

1 0.907⁎⁎⁎ 0.963⁎⁎⁎ 0.251⁎⁎⁎ 0.164⁎⁎⁎ −0.117⁎⁎⁎ 0.040⁎⁎⁎ −0.145⁎⁎⁎ −0.059⁎⁎⁎ 0.093⁎⁎⁎ 0.006⁎ 0.135⁎⁎⁎ −0.036⁎⁎⁎

1 0.822⁎⁎⁎ 0.244⁎⁎⁎ 0.174⁎⁎⁎ −0.101⁎⁎⁎ 0.071⁎⁎⁎ −0.098⁎⁎⁎ −0.054⁎⁎⁎ 0.081⁎⁎⁎ 0.011⁎⁎⁎ 0.176⁎⁎⁎ −0.031⁎⁎⁎

1 0.233⁎⁎⁎ 0.151⁎⁎⁎ −0.114⁎⁎⁎ 0.028⁎⁎⁎ −0.147⁎⁎⁎ −0.056⁎⁎⁎ 0.093⁎⁎⁎ 0.007⁎ 0.123⁎⁎⁎ −0.031⁎⁎⁎

1 0.800⁎⁎⁎ −0.318⁎⁎⁎ 0.602⁎⁎⁎ 0.089⁎⁎⁎ −0.031⁎⁎⁎ 0.008⁎⁎ −0.155⁎⁎⁎ −0.060⁎⁎⁎ −0.031⁎⁎⁎

−0.006 −0.070⁎⁎⁎ 0.018⁎⁎⁎ 0.018⁎⁎⁎

1 0.094⁎⁎⁎ 0.054⁎⁎⁎ 0.091⁎⁎⁎ 0.007⁎⁎ 0.025⁎⁎⁎ 0.022⁎⁎⁎ 0.029⁎⁎⁎

Variable

STRICTNESS

POLINV

NI

LIQUIDITY

CAPINT

LNTA

LNAGE

STRICTNESS POLINV ROA LIQUIDITY CAPINT LNTA LNAGE

1 0.332⁎⁎⁎ 0.040⁎⁎⁎ −0.015⁎⁎⁎ −0.110⁎⁎⁎ −0.019⁎⁎⁎

1 −0.033⁎⁎⁎ −0.077⁎⁎⁎ 0.040⁎⁎⁎ 0.064⁎⁎⁎ 0.028⁎⁎⁎

1 0.154⁎⁎⁎ −0.276⁎⁎⁎ −0.155⁎⁎⁎ −0.065⁎⁎⁎

1 −0.051⁎⁎⁎ −0.092⁎⁎⁎ −0.021⁎⁎⁎

1 0.383⁎⁎⁎ 0.170⁎⁎⁎

1 0.252⁎⁎⁎

1

0.004

PROVGDP

1 −0.152⁎⁎⁎ 0.661⁎⁎⁎ 0.220⁎⁎⁎ −0.026⁎⁎⁎

POLFINE

⁎ p b 0.10. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

and average foreign ownership is approximately 14%. Approximately 18.7% of the firms have some foreign ownership, 13.2% have foreign control, and 5.5% are joint ventures with no more than 50% foreign ownership. The environmental levies paid range between slightly above zero to 3.2% of total assets, but the average was only about 0.002 or 0.2% of assets. GDP per capita ranges between 4.1 and 40.6 (4100 to 40,600 RMB), with an average (weighted by firms) of 16.5 (16,500 RMB). Table 3 compares the summary statistics of the variables over four subsamples of firms: those with no foreign ownership, those with some foreign ownership, those with some, but less than or equal to 50% foreign ownership, and those with over 50% foreign ownership. Compared to the average levy paid by firms having foreign ownership, firms without foreign ownership pay almost twice as much (0.0015 vs. 0.0025). The difference in average levies paid by foreign firms with and without controlling foreign ownership is smaller, but interestingly, foreign firms without controlling foreign ownership do pay significantly lower levies than those with controlling foreign ownership. For both proxies of provincial development, the subsample of firms with foreign ownership score higher than those without foreign ownership, and the subsample of firms with foreign control score higher than those without, which suggests that foreign capital providers are attracted to more developed provinces, especially when they hold a controlling interest. Together these are important observations, because some previous literature find that foreign firms pollute less than local firms (Jiang et al., in press). Therefore our finding of smaller environmental levies for foreign firms could be construed as simply reflecting these lower pollution levels, rather than FDI concessions. However, there is no reason to expect joint venture firms to pollute less than foreign controlled firms, especially because the joint venture firms tend to be in less developed provinces. This suggests that the reduction in environmental

levies for foreign firms is at least partially due to FDI concessions. The summary statistics support Hypothesis 1, but since the control variables in each subsample are significantly different from each other, it is important to investigate it using regression analysis, to control other factors that affect environmental levies. Table 4 presents the Pearson correlation among the variables. The negative correlations between foreign involvement variables and ENVLEVY suggest that levies are lower for foreign owned firms, which also gives preliminary support to Hypothesis 1. The correlation between provincial development variables and ENVLEVY are also negative, which suggests that pollution taxes are lower for firms in better developed provinces, which supports Hypothesis 2. One explanation for this observation is that better developed provinces have stricter regulations and enforcement, which leads to better compliance and ultimately less polluting. The reduction in the amount of pollutants may offset the higher cost per unit of pollutant. Indeed, the correlations between the development variables and STRICTNESS are positive and the correlation between ENVLEVY and STRICTNESS is negative, which tends to support this explanation. In any case, since the correlations are univariate relations, they do not necessarily represent the relations ceteris paribus. One potential problem for interpreting our results lies in the fact that the foreign involvement variables are positively correlated with the provincial development variables.11 This observation is not surprising, as better developed provinces will tend to have the infrastructure and skilled labor that is conducive to FDI and more FDI leads to greater economic development. Table 5 presents our main results based on the continuous main variable FOROWN. Columns 1 and 2 are based on MARKETIZATION as the 11 Note that while significantly greater than zero, the correlations between foreign ownership and provincial development variables range between 0.15 and 0.25, so multicolinearity is not a concern.

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

Q. Chen et al. / International Review of Financial Analysis xxx (2013) xxx–xxx

measure for provincial development, and Columns 3 and 4 use provincial GDP per capita. In each case the coefficients are significantly negative for FOROWN, so environmental levies are lower for firms with greater foreign involvement, which supports Hypothesis 1. We also find that both provincial development variables are negatively related to environmental levies, so levies are lower for firms in better developed provinces, which supports Hypothesis 2. This finding suggests that there are proportionally fewer heavily polluting firms in better developed provinces, which is consistent with the media report we mention in Footnote 4. Columns 2 and 4 report results for regressions that interact foreign ownership with provincial development. The coefficients are significantly positive in both cases (albeit only marginally significant in the case of provincial GDP per capita), which confirms that the reduction in environmental levies enjoyed by foreign firms is lower for more developed provinces that may have less need to attract FDI. This finding is consistent with Hypothesis 3. Our control variables are also generally significant. Consistent with intuition, firms from provinces with stricter pollution controls and greater pollution investment pay lower environmental levies, and provincial pollution fines are also negatively related. With the exception of POLFINE, these are consistent with the correlations in Table 4, although significance levels are sometimes lower in the regressions. Firms with higher net incomes pay more levies, but larger, older, more liquid and more capital intensive firms pay less. Table 6 presents results using dummy variables indicating different levels of foreign ownership. Columns 1–3 are based on MARKETIZATION and Columns 4–6 are based on provincial GDP per capita. The results are generally consistent with those in Table 5. Intuition suggests that the most pronounced effect should be observed in firms where foreign ownership takes on a dominant role (as indicated by FORCTRLDUM). It is possible that concessions received by foreign firms might depend on the bargaining power of these firms and the respective host governments (Ding et al., 2012). As in any bargaining model, rent allocated between the host country and the MNC depends on their relative strength. However, the results from Table 6 do not support this intuition. The coefficients for FORCTRLDUM are no larger than

7

those of FOROWNDUM, and the significance levels are also lower. In a multi-country study, the bargaining power of respective host countries cannot be ignored. However, in a single-country study such as ours, the bargaining power of host governments systematically affects all firms entering that country, so this concern is less relevant. Also, the bargaining power of firms is likely reflected in their respective characteristics such as size and industry. To the extent that these firm characteristics are properly controlled, the remaining effect should represent concessions to attract FDI into the particular regions, which provides support for Hypothesis 1. Both MARKETIZATION and provincial GDP per capita are negatively associated with ENVLEVY, which supports Hypothesis 2. This observation could result from better developed provinces having stricter environmental policies that lead to less polluting, which can offset and even reverse the higher levies per unit of pollution charged by better developed provinces (Wang & Wheeler, 1996). On the other hand, the interaction between foreign involvement and provincial development is significantly positive for most of the models. The exceptions are the interaction between FORJVDUM and MARKETIZATION and the interaction between FORCTRLDUM and PROVGDP, which are positive, but not significant, and they do not suggest a particular pattern related to foreign control. However, the positive results are mostly consistent with Hypothesis 3, suggesting that better developed provinces reduce FDI concessions related to environmental levies compared to less developed provinces. With respect to the control variables, pollution fine is negatively related to environmental levies in most cases. Firms from provinces with greater pollution fines seem to take more precautions to reduce pollution and the associated environmental levies. As expected, both STRICTNESS and POLINV reduce environmental levies paid (although STRICTNESS is not significant in models using PROVGDP to proxy provincial development). Firms that operate in strict environments with greater investment in pollution controls pay lower levies. Profitability is significant and positive in all cases. More profitable firms are likely to produce more output, so they are also likely to pollute more and

Table 5 Regression of environmental levies on foreign ownership proportion. This table presents results for the regression of environmental levies on foreign involvement and provincial development. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FOROWN is a continuous variable, defined as the book value equity percentage owned by foreign investors. MARKETIZATION and PROVGDP are proxies for provincial development. MARKETIZATION is an index developed using 23 indicators in 5 key areas of provincial economic development. PROVGDP is the provincial GDP per capita in thousands of RMB. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. MARKETIZATION

PROV GDP per capita

Variable

1

2

3

4

FOROWN MARKETIZATION PROVGDP FOR_MARKET FOR_PROVGDP POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE Intercept Industry fixed effects Obs. F-test Adj R-sq

−0.0001 (−1.98⁎⁎) −0.0001 (−4.67⁎⁎⁎)

−0.0012 (−3.16⁎⁎⁎) −0.0001 (−5.32⁎⁎⁎)

−0.0001 (−2.19⁎⁎)

−0.0004 (−2.52⁎⁎)

−0.1790 (−5.72⁎⁎⁎)

−0.2040 (−5.98⁎⁎⁎)

−0.0000 (−1.7⁎) −0.0001 (−1.68⁎) −0.0002 (−3.53⁎⁎⁎) 0.0043 (33.07⁎⁎⁎) −0.0000 (−2.54⁎⁎) −0.0002 (−16.95⁎⁎⁎) −0.0007 (−54⁎⁎⁎) −0.0001 (−3.49⁎⁎⁎) 0.0117 (32.18⁎⁎⁎) yes 75676 223.10⁎⁎⁎ 0.1235

0.1370 (1.85⁎) −0.0000 (−1.85⁎) −0.0001 (−1.4) −0.0002 (−3.49⁎⁎⁎) 0.0043 (33.06⁎⁎⁎) −0.0000 (−2.52⁎⁎) −0.0002 (−16.96⁎⁎⁎) −0.0007 (−54.03⁎⁎⁎) −0.0001 (−3.46⁎⁎⁎) 0.0117 (32.18⁎⁎⁎) yes 75676 218.62⁎⁎⁎ 0.1235

0.0001 (2.9⁎⁎⁎) −0.0000 (−2.31⁎⁎) −0.0001 (−2.22⁎⁎) −0.0002 (−4.09⁎⁎⁎) 0.0043 (32.97⁎⁎⁎) −0.0000 (−2.55⁎⁎) −0.0003 (−17.2⁎⁎⁎) −0.0007 (−54.23⁎⁎⁎) −0.0001 (−3.62⁎⁎⁎) 0.0121 (33.46⁎⁎⁎) yes 75676 222.84⁎⁎⁎ 0.1234

−0.0000 (−2.37⁎⁎) −0.0001 (−1.76⁎) −0.0002 (−3.83⁎⁎⁎) 0.0043 (32.99⁎⁎⁎) −0.0000 (−2.57⁎⁎) −0.0003 (−17.27⁎⁎⁎) −0.0007 (−54.23⁎⁎⁎) −0.0001 (−3.67⁎⁎⁎) 0.0121 (33.5⁎⁎⁎) yes 75676 218.48⁎⁎⁎ 0.1234

⁎ p b 0.10. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

8

Q. Chen et al. / International Review of Financial Analysis xxx (2013) xxx–xxx

Table 6 Regression of environmental levies on foreign ownership dummy variables. This table presents results for the regression of environmental levies on foreign involvement dummies and provincial development. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FOROWNDUM, FORJVDUM, and FORCTRLDUM are dummy variables equal to 1 when firms have foreign investors, when foreign investors have less than or equal to 50%, and when foreign investors control more than 50% of total book equity, 0 otherwise. MARKETIZATION and PROVGDP are proxies for provincial development. MARKETIZATION is an index developed using 23 indicators in 5 key areas of provincial economic development. PROVGDP is the provincial GDP per capita in thousands of RMB. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. MARKETIZATION Variable

1

FOROWNDUM FORJVDUM FORCTRLDUM MARKETIZATION FORDUM_MAR FORJV_MAR FORCTRL_MAR PROVGDP FORDUM_GDP FORJV_GDP FORCTRL_GDP POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE Intercept Industry fixed effects Obs. F-test Adj R-sq

−0.0008 (−3.05⁎⁎⁎) −0.0001 (−5.19⁎⁎⁎) 0.0001 (2.63⁎⁎⁎)

PROV GDP per capita 2 −0.0007 (−1.77⁎) −0.0001 (−5.21⁎⁎⁎) 0.0001 (1.28)

−0.0000 (−2.3⁎⁎) −0.0001 (−1.84⁎) −0.0002 (−3.89⁎⁎⁎) 0.0043 (33.00⁎⁎⁎) −0.0000 (−2.54⁎⁎) −0.0003 (−17.29⁎⁎⁎) −0.0007 (−53.54⁎⁎⁎) −0.0001 (−3.71⁎⁎⁎) 0.0121 (33.38⁎⁎⁎) Yes 75676 218.53⁎⁎⁎ 0.1235

−0.0000 (−2.26⁎⁎) −0.0001 (−1.97⁎⁎) −0.0002 (−3.79⁎⁎⁎) 0.0043 (33.08⁎⁎⁎) −0.0000 (−2.73⁎⁎⁎) −0.0003 (−17.25⁎⁎⁎) −0.0007 (−54.74⁎⁎⁎) −0.0001 (−3.59⁎⁎⁎) 0.0121 (33.44⁎⁎⁎) Yes 75676 218.42⁎⁎⁎ 0.1234

3

4 −0.0004 (−3.24⁎⁎⁎)

−0.0008 (−2.22⁎⁎) −0.0001 (−5.22⁎⁎⁎) 0.0001 (2.09⁎⁎)

−0.0000 (−2.38⁎⁎) −0.0001 (−1.86⁎) −0.0002 (−3.77⁎⁎⁎) 0.0043 (32.93⁎⁎⁎) −0.0000 (−2.63⁎⁎⁎) −0.0003 (−17.11⁎⁎⁎) −0.0007 (−54.61⁎⁎⁎) −0.0001 (−3.59⁎⁎⁎) 0.0121 (33.33⁎⁎⁎) Yes 75423 217.58⁎⁎⁎ 0.1234

5 −0.0006 (−2.97⁎⁎⁎)

−0.2110 (−6.13⁎⁎⁎) 0.1400 (2.33⁎⁎)

−0.1990 (−6.29⁎⁎⁎)

−0.0000 (−1.86⁎) −0.0001 (−1.3) −0.0002 (−3.48⁎⁎⁎) 0.0043 (33.07⁎⁎⁎) −0.0000 (−2.49⁎⁎) −0.0002 (−17⁎⁎⁎) −0.0007 (−53.34⁎⁎⁎) −0.0001 (−3.51⁎⁎⁎) 0.0117 (32.07⁎⁎⁎) Yes 75676 218.75⁎⁎⁎ 0.1236

−0.0000 (−1.57) −0.0001 (−1.43) −0.0001 (−3.15⁎⁎⁎) 0.0043 (33.20⁎⁎⁎) −0.0000 (−2.75⁎⁎⁎) −0.0002 (−16.97⁎⁎⁎) −0.0007 (−54.46⁎⁎⁎) −0.0001 (−3.44⁎⁎⁎) 0.0117 (32.07⁎⁎⁎) Yes 75676 218.72⁎⁎⁎ 0.1236

6

−0.0002 (−1.71⁎)

−0.2000 (−5.95⁎⁎⁎)

0.2130 (2.1⁎⁎) 0.0938 (1.36) −0.0000 (−1.78⁎) −0.0001 (−1.45) −0.0002 (−3.34⁎⁎⁎) 0.0043 (33.01⁎⁎⁎) −0.0000 (−2.6⁎⁎⁎) −0.0002 (−16.81⁎⁎⁎) −0.0007 (−54.38⁎⁎⁎) −0.0001 (−3.4⁎⁎⁎) 0.0117 (32⁎⁎⁎) Yes 75423 217.78⁎⁎⁎ 0.1235

⁎ p b 0.10. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

therefore pay more environmental levies. Larger firms pay lower levies as a proportion of their assets. Similarly, the coefficients of liquidity, capital intensity, and firm age are also negative. One could argue that foreign firms pay lower levies simply because they pollute less than local firms, and not because provinces use their discretion to charge them lower levies as a concession to attract FDI. Christmann and Taylor (2001) suggest that foreign firms improve selfregulation in countries with weak regulations. Liang (2006) suggests that foreign firms can crowd out less efficient local firms, leading to an overall environmental benefit from FDI. Other studies document the FDI reduces air pollution and some other forms of pollution (Bao, Chen, & Song, 2010; Jiang et al., in press; Kirkulak et al., 2011; Zheng, Kahn, & Liu, 2010). Although we do not have firm level data on pollution emissions, we argue that the reduction in environmental levies experienced by foreign firms is not completely explained by a reduction in pollution. First, we control for many provincial and firm level characteristics that previous literature documents as important in explaining pollution emissions. Second, Table 3 shows that joint ventures have significantly lower environmental levies compared to foreign controlled firms. While provincial governments may be more inclined to provide concessions to joint venture relative to foreign controlled firms, it would be unlikely for joint ventures to pollute less than foreign controlled firms. However, Table 3 also shows that all other variables that we consider are also significantly different between joint venture firms and foreign controlled firms. Third, to confirm that the difference in levies remains after controlling for differences in other factors, we regress environmental levies on both FORJVDUM and FORCTRLDUM while controlling for other factors. The results are reported in Table 7. We find that when both foreign ownership dummies are included, only FORJVDUM significantly reduces levies, while FORCTRLDUM does not significantly affect them. This finding offers strong evidence that

the reduction in levies for foreign firms are at least partly due to provincial concessions made to attract FDI, particularly for joint venture firms with 50% or less foreign ownership.12

5. Conclusion Foreign direct investment (FDI) is increasingly being recognized as an important driver of economic growth in many developing countries. FDI not only infuses much needed capital but also transfers technology and other managerial skills. Recognizing its many potential benefits, countries often strive to create an environment conducive to FDI and provide various concessions to foreign capital providers. Nonetheless, the efficacy of incentives as a determinant for attracting FDI is still much debated. Cross-country studies of tax incentives are not only plagued with the complexities of different tax systems but are also influenced by unobserved country characteristics, which can muddle the results. Focusing on regions within a single country having different economic growth and development provides enough heterogeneity for meaningful analysis and avoids the usual pitfalls found in crosscountry analysis. We also avoid concerns associated with volatile portfolio capital flows by using a unique set of private entrepreneurial firms. We consider FDI incentives from the perspective of foreign capital providers and investigate the relation between foreign involvement in firm ownership and concessions provided to private firms in different regions of China with different levels of economic development. In 12 In untabulated regressions, we find similar results when we consider other specifications that concern firms with 100% foreign equity, as well as dummy variables based on quartiles and deciles of foreign ownership. The largest reduction in levies occurs when foreign ownership is less than or equal to 50%, although the reduction is larger for more foreign ownership up to about 50%.

Please cite this article as: Chen, Q., et al., Foreign direct investment concessions and environmental levies in China, International Review of Financial Analysis (2013), http://dx.doi.org/10.1016/j.irfa.2013.12.002

Q. Chen et al. / International Review of Financial Analysis xxx (2013) xxx–xxx Table 7 Regression comparing joint ventures with foreign controlled firms. This table presents results for the regression of environmental levies on foreign involvement dummies. ENVLEVY is the amount of environmental levies paid by a firm for pollution in 2004 scaled by its total assets. FORJVDUM and FORCTRLDUM are dummy variables equal to 1 when foreign investors have less than or equal to 50%, and when foreign investors control more than 50% of total book equity, 0 otherwise. POLFINE, STRICTNESS, and POLINV capture the provincial environmental regulation and enforcement. POLFINE is the amount of fines for pollution (in units of 100,000 RMB). STRICTNESS indicates the provincial enforcement stringency. POLINV is the amount invested in pollution control (in units of 100,000,000 RMB). NI is net income scaled by assets. LIQUIDITY is the current ratio, defined as current assets divided by current liabilities. CAPINT is the total assets divided by total revenue. LNTA is the natural log of total assets (in units of 1,000 RMB). LNAGE is the natural log of the number of years since the founding of the firm. Variable FORJVDUM FORCTRLDUM POLFINE STRICTNESS POLINV NI LIQUIDITY CAPINT LNTA LNAGE Industry fixed effects Obs. F-test Adj R-sq

−0.0002442 (−3.29⁎⁎⁎) −0.0000699 (−1.38) −0.0000000 (−0.01) −0.0002417 (−6.70⁎⁎⁎) −0.0001692 (−3.57⁎⁎⁎) 0.0042901 (33.06⁎⁎⁎) −0.0000191 (−2.69⁎⁎⁎) −0.0002524 (−17.37⁎⁎⁎) −0.0006730 (−53.63⁎⁎⁎) −0.0000547 (−3.41⁎⁎⁎) yes 75982⁎ 223.08⁎⁎⁎ 0.1230⁎⁎

⁎ p b 0.10. ⁎⁎ p b 0.05. ⁎⁎⁎ p b 0.01.

other words, we directly attempt to observe whether the perceived benefits of investing in a country that seemingly offers concessions actually translate into realized benefits. Differences in fees levied on pollution emissions (environmental levies) provide a good proxy for measuring provincial concessions made for the purpose of attracting investment. We find that firms with greater foreign ownership pay lower environmental levies, which indicates that concessions are made to attract FDI to China, and that firms actually benefit from foreign ownership involvement. Needless to say, providers of foreign capital benefit as well. Furthermore, this reduction in levies is greater for joint venture firms that have ownership stakes of less than or equal to 50%. However, these concessions are conditional on the level of development of the province offering them, with better developed provinces providing fewer concessions for FDI. This finding indirectly contributes to the existing negotiation theories that involve MNCs and host governments: Countries or regions that possess stronger fundamentals have better negotiation power. One limitation of our study is that we cannot directly control for firm level pollution emissions, although we do control for other factors related to pollution. Recent studies have shown that the market rewards firms that take efforts to mitigate environmental impact (Aggarwal & Dow, 2012). Further research may examine the market response to changes in environmental levies. Environmental regulation is one of the many factors to consider when investors make international investment. Further studies could also explore how legal, ethical, cultural, and socio-political institutions affect the relation between environmental regulations and international investment and FDI (Cressy, Cumming, & Mallin, 2012), particularly as they relate to environmental levies in China.

9

Acknowledgments We thank conference participants at the Pingyao Forum and an anonymous referee for helpful comments. We also thank Yanxue (Emma) Liu for excellent research assistance.

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