Motivated by Hoff and Stiglitz’s (Am Econ Rev 94(3):753–763, 2004) theory, we examine empirically how the creation of “rules of the game” affect the behavior of economic agents in a transition economy. Using a sample of Chinese state-owned enterprises in which controlling ownership was transferred to private acquirers between 1994 and 2006, we find that the post-privatization performance (PPP) of firms depends on institutional factors. Before 2003, we observe severe post-privatization tunneling behaviors by acquirers and worse PPP. However, from 2003, when the State issued regulations against tunneling and strengthened enforcement, the incidence of tunneling behaviors declined, and PPP improved. We find that better implementation of ownership transfer and longer prior experience of private acquirers are key factors that contribute to the improvement.
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