Government fiscal stress and firms’ choice of affiliates

Abstract

This paper investigates the impact of fiscal stress on the corporate structure of affiliates. When facing a high fiscal deficit, governments may prompt firms to set up subsidiaries rather than branches as subsidiaries pay more taxes locally. Consistent with the prediction, we find that fiscal stress is positively associated with firms’ tendency to establish subsidiaries, and that the relationship is weaker in cities with higher GDP or higher administrative hierarchy. We also show that firms’ incentives to obtain cheap land and public subsidies induce their cooperative behavior. Cross-sectional analyses indicate that non-SOE firms and those with higher growth potential are more likely to align with deficit-facing governments’ preferences. Overall, our findings suggest that governments play an important role in shaping firms’ organizational choice.