Journal of Law and Economics Vol. 53, No. 4 (November 2010), pp. 629-650
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Using firm-level data from a World Bank survey, this paper examines how legal
development in China relates to various firm decisions. I find that a more active
court system is associated with more investment, more adoption of technology,
more innovation, and more complex transactions. Specifically, when a higher
percentage of business disputes are resolved through the court system, firms
tend to have higher investment rates, higher propensities to adopt new automated
technology, and higher probabilities of developing new products. In
addition, they tend to have more nonlocal sales. These findings are consistent
with a sophisticated version of the rights hypothesis, in which the rule of law
eventually replaces relation-based governance as a superior governance mechanism.
I find two limitations of China’s legal system. The court system does a
better job facilitating the growth of state-owned enterprises than of private firms,
and it protects local firms better than nonlocal firms.