Profiting from Gaizhi: Management Buyout during China’s Privatization

During the late 1990s, China introduced the gaizhi process for privatizing stateowned firms. Under gaizhi, managers could acquire their firms at a price that was based on recent profitability. Systematic analysis of longitudinal data reveals the following: (1) There is a statistically significant 4 percent decrease in net margin relative to trend in the one year period immediately prior to privatization; (2) There is no statistically meaningful difference in net margin in the period after privatization relative to the period one year or more before privatization. These findings suggest that managers intentionally suppressed the performance of their firms so as to acquire them at less than fair value. We test and reject other, more innocuous explanations for this profit pattern. We are grateful to Thomas Hubbard, Ben Jones and Scott Stern for comments and helpful conversations. We are indebted to Yang Yao for the China SOE Survey Data. We also thank the participants of the 5 International Industrial Organization Conference at Savannah. All errors that remain are ours. † Correspondence can be addressed to Susan Feng Lu, Kellogg School of Management, Northwestern University by email: [email protected].