The Externalities of Corruption: Evidence from Entrepreneurial Firms in China

Exploiting China’s anti-corruption campaign, we show that following a decrease in corruption, firm performance improves. Small and young firms benefit more. We identify the channels through which corruption hampers firm performance. Following the anti-corruption campaign, the allocation of capital and labor becomes more efficient. Firms operating in ex ante more corrupt environments experience larger productivity gains, higher growth of sales, and lower cost of debt than other firms. Taken together, our results suggest that corruption is an inefficient equilibrium for an economy because it creates negative externalities.