Local Government Debt and Corporate Fraud: Evidence from China

Local government debt acts as a double-edged sword for economic development. While it has effectively stimulated local economic growth, it has also led to crowding-out consequences of crowding out corporate financing and investment. This study analyzes data of Chinese listed firms from 2007 to 2020, revealing the detrimental effects of local government debt on firms’ misconduct. We find that local government debt is positively related to corporate fraud, and the results remain robust to a series of sensitivity tests. The mechanism tests demonstrate that an increase in local government debt exerts pressure on firms’ financing and performance. Moreover, we observe that the adverse effects are more pronounced in private firms, and firms with poor governance systems.