China’s Innovation Challenge: Evidence from industry competition, government subsidies and political turnover

In this thesis, we investigate the challenge of corporate innovation in China from three aspects: industry competition, government subsidies, and political turnover. Our study enriches the related literature on innovation in the Chinese context by using a large panel of industrial firms. In chapter 2, we investigate the effect of industry competition on corporate innovation. Using a panel of 555,124 industrial firms over the period from 1998 to 2007, we find that firm-level innovation is negatively associated with industry competition, and the negative relation is stronger in industries that are more dependent on external finance. Further evidence shows that financing constraints tighten the negative effect of competition on innovation. Our study provides clear identification of a causal effect of competition on innovation by using a difference-in-differences (DID) approach that relies on a plausibly exogenous shift in industrial openness to foreign investment and employing instrumental variables (IV) approach that relies on a time-varying instrument for industry competition. In chapter 3, we explore the impact of government subsidies on corporate innovation. Using a panel of 663,699 industrial firms over the period from 1998 to 2008, we find that government subsidies have a positive direct effect on corporate innovation. I confirm the causal effect of subsidies on innovation by using an IV estimation and a DID specification. The positive direct effect is more pronounced for private firms, financially constrained firms, firms in industries with low external finance dependence (EFD) or high-tech intensiveness, and firms located in cities with low financial development or low foreign direct investment. Furthermore, subsidies have a greater positive indirect effect on innovation activities for firms without subsidies than firms with subsidies. The paper sheds light on the implications of subsidies in innovation. In chapter 4, we focus on the influence of political turnover on the finance-innovation nexus. Using a panel of 739,672 industrial firms across 305 cities over the period from 2003 to 2014, we find that local political uncertainty arising from local political turnover decreases the positive effect of city-level financial development on corporate innovation while local political turnover alone promotes corporate innovation. The results are robust to the use of various estimation methods. Further evidence shows that the moderating effect played by local political turnover is various across turnover types, political connections, and financial constraints. Our findings shed light on how both political and financial systems influence corporate innovation in China with a weak institutional environment.