The Reverse Bail-Out of Indebted Local Governments by Local Firms

Using a dataset of over one million local government procurement contracts in China, we study whether the government’s indebtedness causes delays in payment which can be averse to suppliers’ financial conditions. Higher local government distress predicts an increase in accounts receivables for suppliers participating in procurement auctions after the distress period increase. Local governments are less likely to delay payments in areas with more property rights and less likely to delay payment to (1) large companies, (2) those in high-tech industries, (3) state-owned suppliers. Instrumenting for government financial distress by connections of local government officials to senior central communist party leaders increases the point estimates. Our results suggest that local government indebtedness induces a bail-in by firms supplying goods and services to the government. Governments appear to follow a pecking order to pay for government contracts, and firms bailing in the local government are more likely to fail.