Going bankrupt in China
The lack of an efficient and independent judicial system is a major obstacle to economic development. Several studies have shown that, especially in developing countries, courts are often slow at processing cases, lack specialised judges, and are subject to political interference (Djankov et al. 2008, Dakolias 1999, Rodriguez and Ehrichs 2007). The effects of these frictions in contract enforcement can percolate through the financial system in the form of high interest rates and limited access to credit. These, in turn, affect firms’ ability to invest and innovate and hinder the reallocation of capital towards more productive projects.
This issue is prominent in China, where local courts are traditionally slow and suffer from the interference of local politicians when dealing with bankruptcy cases (Fan et al. 2013, Henderson 2007). Local politicians have strong incentives to delay the liquidation and keep in operation low-productivity and financially distressed state-owned firms to contain unemployment, avoid social unrest, and promote their political careers. Despite its importance, we still know very little about how the judicial system deals with insolvency resolution in China and what are its effects on the real economy.
Bankruptcy in China: Uncovering new stylised facts
In a recent working paper (Li and Ponticelli 2020), we collect new case-level data to shed light on how bankruptcy works in China. How the second-largest economy in the world deals with corporate insolvency has important policy implications, especially in light of the recent increase in corporate defaults that followed a decade-long debt boom. Still, this question has been so far largely unexplored due to the lack of data.
We collected detailed information on 2,021 bankruptcy cases filed in China between 2011 and 2019. Our data source is a new online platform created by the Chinese Supreme Court to allow debtors and creditors to monitor the evolution of bankruptcy cases. The platform provides access to a digitised version of the court documents accompanying each case, from which we extracted a large set of case and firm characteristics.
This new data allowed us to uncover a set of stylised facts on bankruptcy in China. Similar to other emerging economies, the vast majority of Chinese bankruptcies are liquidations (77%). Over half of the cases in our sample involve firms operating in manufacturing, construction, and real estate (Figure 1).
Figure 1 Number of bankruptcy cases by year, type of case and sector
a) By type of case
b) By sector
Notes: Number of bankruptcy cases by year of acceptance, 2011 to 2019. Source: Authors’ calculations using data from the National Corporate Bankruptcy Information Disclosure Platform.
Liquidation cases are mostly initiated by unsecured creditors, while banks – whose claims tend to be secured by some form of collateral – initiate only 7.5% of cases (Figure 2). The average duration of bankruptcy cases observed in the data is 1.6 years, around 60% longer than the average duration observed in the US during the same period according to World Bank data.1 However, there is a large variation in case duration, which spans from a few months to around eight years. Reorganisations and cases involving small firms tend to be closed faster than liquidations and cases involving large firms.
Figure 2 Distribution of case duration
a) All closed cases
b) Cases initiated in traditional civil courts vs specialised courts
Notes: The figure shows the distribution of the variable ‘time in court’, which captures the duration of each case in years. Panel (a) pools all closed cases in our sample. Panel (b) differentiates between cases initiated in traditional civil courts versus specialised courts.
The effects of introducing specialised courts on insolvency resolution
Our paper also provides a first attempt to estimate the effects of introducing specialised courts. As in many other emerging economies, until recent years the Chinese judicial system did not have courts specialised in bankruptcy cases. Despite being more time-consuming and complex than the average civil case, bankruptcy cases were filed in local civil courts, which lack specialised judges and tend to operate under the oversight of local party officials.
Between 2007 and 2017, in an attempt to increase the legal protection of creditors, China introduced 97 specialised bankruptcy courts in different cities. Compared to traditional civil courts, specialised courts are run by better-trained judges and are part of an effort by the central government to limit local governments’ intervention in bankruptcy cases (INSOL 2018). Thus, it is possible to exploit the introduction of specialised courts as a shock to judicial efficiency and independence.
From an identification standpoint, studying how the introduction of specialised courts has affected insolvency resolution in China is challenging. On the one hand, specialised courts were introduced at different times in different cities, offering the possibility to exploit their staggered introduction as an identification device. However, cities that introduced specialised courts might be on a different economic cycle, which would also affect the type of firms going bankrupt.
To deal with this challenge, we exploit the fact that, even after the introduction of specialised courts, bankruptcy cases were still handled by both traditional civil courts and specialised courts within the same city, in almost equal proportions. This feature of the Chinese judicial system allows us to compare cases initiated in different courts within the same city and year.2
Figure 3 Allocation of cases in traditional vs specialised courts
a) Percentage of total bankruptcy cases entering traditional civil courts vs specialised courts (2011–2019)
b) Average share of cases allocated to specialised courts in each city, by quarter relative to introduction of first specialised court in that city
Notes: Panel (a) shows the percentage of total bankruptcy cases entering in traditional civil courts versus specialised courts by year, between 2011 and 2019. Panel (b) shows that average share of cases allocated to specialised courts in each city, by quarter relative to the introduction of the first specialised court in that city (which we set as t = 0).
We start by documenting how specialised courts affected the performance of local courts. We find that specialisation leads to faster resolution. Case duration in specialised courts is 35% lower than in traditional civil courts when comparing similar cases initiated at the same time in the same city. This corresponds to a decline in case duration of around 210 days.
To investigate the effect of specialisation on judicial independence, we focus on the judicial treatment of state-owned versus private firms. According to the Chinese Supreme Court, one of the objectives of specialised courts was to facilitate an orderly and swift liquidation of unproductive state-owned firms and the reallocation of their resources to the rest of the economy. We find that the effect of specialisation on case duration is significantly larger for cases regarding state-owned firms than privately owned firms. In particular, the magnitude of our estimates indicates that specialised courts reduce case duration for privately owned firms by around 198 days, and for state-owned firms by 506 days.
How do faster and more independent courts affect the real economy?
What were the effects of these specialised courts on the local economy? Exploiting the staggered introduction of courts across cities, we study their effect on several measures of local economic development.3 A more efficient and independent bankruptcy system can promote local economic development by:
- Facilitating the liquidation of low-productivity firms and favouring a quicker reallocation of their real assets, their labour force and their market shares to other firms in the economy (Bernstein et al. 2019).
- Increasing the expected recovery rate of creditors and thus promoting lending to firms that operate under specialised courts (Visaria 2009).
We focus on three indicators of local economic performance that are available in our data: entry of new firms, average firm productivity, and the share of local labour employed in industries with higher diffusion of ‘zombie’ firms. We define zombie firms as low-productivity firms benefiting from financing conditions that are not justified by their fundamentals (following Caballero et al. 2008).
Using data on publicly-listed firms we rank industries based on the diffusion of zombie firms. We define industries above the median of this measure as zombie-intensive industries, or Z-industries.
We find that cities that introduced courts specialised in bankruptcy experienced a 3%-faster increase in the number of firms and a 4.5%-larger increase in the average product of capital of local firms relative to cities where insolvency is still resolved exclusively by civil courts. We also find that cities that introduced specialised courts experienced a 1.7 percentage points larger decline in the share of labour employed in zombie-intensive industries.
Overall, our results are consistent with specialised courts fostering faster liquidation of low-productivity state-owned firms, which positively affects entry and average productivity of surviving firms, as well as the reallocation of local economies from zombie-intensive to non-zombie-intensive sectors.
Increasing pressure on the institutions in charge of resolving insolvency.
In the last decade, the Chinese economy experienced a massive increase in corporate debt. Several factors have contributed to this debt boom: the stimulus policies of 2009–2010, the development of a corporate bond market, and the fast growth of shadow banking.
Academics and policymakers have raised concerns about the risks associated with this credit boom. The Chinese central government has also expressed concerns about the large number of zombie firms and recognised the lack of efficient bankruptcy procedures that could facilitate their liquidation or restructuring. Furthermore, the COVID-19 crisis will likely amplify the number of bankruptcy filings in the coming months and years.
Despite the increasing pressures to improve the Chinese insolvency-resolution system, there was, until now, virtually no academic research on how bankruptcy works in China. Our paper can contribute to closing this gap in the literature and inform policymakers. However, there are still limitations to our data and more research is necessary, both on the functioning of the judicial system and on its effects on credit markets and the real economy.
Bernstein, S, E Colonnelli and B Iverson (2019), “Asset allocation in bankruptcy”, Journal of Finance 74(1): 5–53.
Caballero, R J, T Hoshi and A K Kashyap (2008), “Zombie lending and depressed restructuring in Japan”, American Economic Review 98(5): 1943–77.
Dakolias, M (1999), “Court performance around the world: A comparative perspective”, World Bank Technical Paper 23.
Djankov, S, O Hart, C McLiesh and A Shleifer (2008), “Debt enforcement around the world”, Journal of Political Economy 116(6): 1105–49.
Fan, J, J Huang and N Zhu (2013), “Institutions, ownership structures, and distress resolution in China”, Journal of Corporate Finance 23(1): 71–87.
Henderson, K (2007), “The rule of law and judicial corruption in China: Half-way over the Great Wall”, in D Rodriguez and L Ehrichs (eds.), Global Corruption Report: Corruption in Judicial Systems, Washington DC: Transparency International, Cambridge University Press.
Li, B, and J Ponticelli (2020), “Going bankrupt in China”, NBER Working Paper w27501.
INSOL (2018), “PRC enterprise bankruptcy law and practice in China”, technical report.
Rodriguez, D, and L Ehrichs, eds. (2007), “Corruption in judicial systems: Global corruption report”, Transparency International.
Visaria, S (2009), “Legal reform and loan repayment: The microeconomic impact of debt recovery tribunals in India”, American Economic Journal: Applied Economics 1(3): 59–81.
1 Doing Business, The World Bank Group (http://www.doingbusiness.org), 2011-2019.
2 Of course, even within a given city and year, cases are not randomly allocated across courts. However, we show that cases handled by traditional versus specialised courts within the same city and year are strongly balanced along both firm and case characteristics
3 This analysis exploits city-level variation, which does not allow us to exploit variation across courts facing the same city-level shocks. Thus, we rely solely on the staggered introduction of specialised courts across cities as a source of identification. To attenuate the concerns associated with endogenous opening of specialised courts, we estimate a discrete time hazard model that studies whether differences in economic trends at city level predict the timing of the introduction of specialised courts across cities. We find that the timing of their introduction is uncorrelated with different measures of local economic performance as captured by contemporaneous and lagged changes in GDP per capita, number of firms, average firm size, and share of manufacturing in local GDP.