The Rise of VIEs in China Balancing State Control and Access to Foreign Capital

We investigate Chinese firms’ use of variable interest entities (VIEs) to evade Chinese regulation on foreign ownership and list in the US. Since VIEs are explicitly designed to circumvent the intent of Chinese law on restricting foreign control, they potentially increase the risk of government intervention and agency conflicts within the firm. The use of VIEs among Chinese firms listed in the US is widespread, growing, and associated with valuation discounts of approximately 25% relative to Chinese non-VIE firms listed in the US. The discount varies predictably with events that change VIE risks and is tempered by better oversight (large auditor and institutional investment) and factors that lower regulatory risk (politically connected directors and high media visibility). To remediate investor concerns, VIE firms are more likely to have these characteristics. Finally, the risk of intervention disciplines VIE managers to curry government favor by funding disaster relief and hiring excess employees.