Local government implicit debt and corporate bankruptcy: Evidence from China

Abstract

We examine the impact of local government implicit debt on corporate bankruptcy risk using data on China's government implicit debt and firm registration records from 2017 to 2022. Our findings show that higher levels of local government implicit debt lead to a significant increase in the bankruptcy rates of regional firms. This result remains robust after a series of endogeneity checks, including controls for policy impacts and instrumental variable estimation. Mechanism analyses suggest the effect is primarily driven by increased government fines on firms and reductions in infrastructure investment. Furthermore, we show that the effect of local government implicit debt on bankruptcy rate is more pronounced in regions with stronger government intervention and non-first-tier cities. We also find that higher levels of implicit debt are associated with lower rates of new firm entry. Overall, these findings shed light on the broader economic consequences of local government financing practices.