Title: Does Competition Encourage Unethical Behavior? the Case of Corporate Profit Hiding in China
Reference Number: 1126
Publication Date: May 2005
JEL Classifcation: L10, D21, H26, G30

Hongbin Cai
University of California Los Angeles

Qiao Liu
The University of Hong Kong

Geng Xiao
The University of Hong Kong


This paper investigates whether market competition enhances firms' incentives to hide profits. We develop a theoretical model of firms' profit hiding behavior in competitive environments and derive several testable hypotheses. We then test the model using a database that covers more than 20,000 large-and-medium-sized industrial firms in China during the period 1995-2002. Our findings show that firms in more competitive market environments — as well as firms in relatively disadvantageous positions — hide a larger share of their profits. This suggests that policies intended to promote competition should be accompanied by policies aiming at strengthening institutional infrastructure and at leveling playing fields.


Key words: Competition, firm behavior, tax evasion, Chinese economy

Last modified: 05/11/2005