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 list in the U.S. Since VIEs are explicitly designed to circumvent Chinese restrictions on foreign investments, they potentially increase the risk of government intervention and agency conflicts within the firm. The use of VIEs among Chinese firms listed in the U.S. is widespread, growing, and associated with valuation discounts of approximately 25 percent relative to Chinese non-VIE firms listed in the U.S. 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 (political connection and high media visibility). To remediate investor concerns, VIE firms are more likely to have these characteristics. Finally, we find that the risk of intervention disciplines VIE managers who curry government favor by contributing to disaster relief and hiring excess employees. Data Availability: Data are available from public sources cited in the text. JEL Classifications: G30; G34; M41; K22.