Capital misallocation in Chinese industrial firms

This paper investigates the impact of volatility in profitability shock, capital price distortion and adjustment costs on capital misallocation among Chinese industrial firms. We estimate a dynamic model pertaining firms' investment decision, incorporating institutional differences between state and private firms, so the model can reproduce salient features observed from Chinese firms. Our analysis shows: (i) capital price distortion is more severe among state firms than private ones; (ii) adjusting capital is more costly for state than private firms; (iii) volatility in profitability shock is a major source that causes capital misallocation for both types of firms.