the determinants of employee ownership in china's privatized rural industry: evidence from...

Journal of Comparative Economics 30, 415–437 (2002)doi:10.1006/jcec.2002.1782

The Determinants of Employee Ownership in China’sPrivatized Rural Industry: Evidence from Jiangsu

and Shandong1

Xiao-yuan Dong

University of Winnipeg, Winnipeg, Manitoba, CanadaE-mail: [email protected]

Paul Bowles

Economics Program, University of Northern British Columbia, Prince George,British Columbia, Canada

and

Samuel P. S. Ho

University of British Columbia, Vancouver, British Columbia, Canada

Received February 22, 2002; revised March 15, 2002

Dong, Xiao-yuan, Bowles, Paul, and Ho, Samuel P. S.—The Determinants of EmployeeOwnership in China’s Privatized Rural Industry: Evidence from Jiangsu and Shandong

This paper examines the determinants of employee share ownership in newly privatizedtownship and village enterprises (TVEs) in Shandong and Jiangsu. We find that expectedfinancial returns, job security, risk preference, and family wealth are important determinantsof employee share holdings. However, the accessibility of share ownership to employeesis also affected by the local leaders’ preferences for managerial buy-outs relative to theirconcern for improving work incentives, their desire to maximize sales revenue, and theposition, residential status, and gender of an employee. J. Comp. Econ., June 2002, 30(2),

1 This research is part of the University of British Columbia Centre for Chinese Research’s projecton rural change in the People’s Republic of China and was carried out with aid of a grant from theInternational Development Research Centre, Ottawa, Canada. We thank James Kung, Greg Dow, LouisPutterman, and Lina Song for their insightful comments. We also benefited greatly from the commentsof participants at workshop at the Hong Kong University of Science and Technology in July 2001 andat the Allied Social Sciences Association meetings in January 2002.

4150147-5967/02 $35.00C© 2002 Association for Comparative Economic StudiesPublished by Elsevier Science (USA)All rights reserved.

416 DONG, BOWLES, AND HO

pp. 415–437. University of Winnipeg, Winnipeg, Manitoba, Canada; Economics Program,University of Northern British Columbia, Prince George, British Columbia, Canada; andUniversity of British Columbia, Vancouver, British Columbia, Canada. C© 2002 Association for

Comparative Economic Studies. Published by Elsevier Science (USA). All rights reserved.

Key Words: employee ownership; privatization; income inequality.

Journal of Economic Literature Classification Numbers: J42, J71, O53, P23.

1. INTRODUCTION

Property rights reform has occupied a central place in the debate over the processof economic transition from a centrally planned to a market-oriented economy.Conventional wisdom in policy-making circles has asserted the importance ofestablishing private property rights in productive assets. However, until the early1990’s, China achieved rapid economic growth without adopting the big bangapproach to privatization favored by countries in the former Soviet bloc. Much ofChina’s growth during the 1980’s occurred in the rural industrial sector, dominatedby enterprises owned by township and village governments.2 In the mid-1990’s,the transition paths followed by China and Central and Eastern European countriesbegan to converge when the Chinese government announced the policy of grasp thelarge and release the small (zhuadafangxiao). The government began to privatizemost small- and medium-scale collective and state enterprises. The privatizationof township and village enterprises (TVEs) fell under this general policy and TVEshave taken the lead in the reform of property rights. Since 1995, millions of TVEshave been sold to enterprise managers, employees, and other private investors.

While the goal of privatization in transition economies, and elsewhere, is primar-ily increasing economic efficiency, no single privatization model has been followedin practice. Privatization policies have differed between countries based on the pol-icy makers’ preferences for factors such as revenue maximization, the speed ofprivatization, and particularly corporate governance structures. Policies have alsodiffered as a result of varying initial conditions and varying political/distributionalobjectives. In all countries, the role of employees as share owners has been oneof the major factors considered in designing privatization programs. The role ofemployee share ownership may have important implications for forms of postpri-vatization corporate governance, for income and wealth inequality, and for sup-port for the privatization program. As a consequence, privatization processes insome countries have been designed to include, and sometimes to favor, employeeshareholders for reasons of both expediency and distributional fairness. In otherscountries no special provisions have been made for employees, and privatization

2 It is difficult, if not impossible, to gauge the exact size of this collective sector because of thepractice of registering private enterprises as collective enterprises. These so-called red hat enterprisesmake official statistics unreliable. Nevertheless, it is a reasonable generalization to say that, in mostprovinces, the rural collective sector was a significant contributor to economic growth in the 1980’s.For a review of the debate on the nature of the collective sector during this period see Bowles and Dong(1999).

EMPLOYEE OWNERSHIP IN RURAL CHINA 417

processes have been designed to place productive assets in the hands of enterprisemanagers, asset companies, or the general citizenry.3

In this paper, we examine the structure of employee share ownership that hasemerged from the privatization of TVEs using a unique data set from Jiangsuand Shandong. Specifically, we present a simple model of share holding determi-nation in rural China to analyze both the reasons why individual employees maychoose to buy or not to buy shares and the context within which these decisions aremade. This context, or decision-making environment for the individual employee,is shaped heavily by the decisions of the local government leadership, which de-signed the privatization process and by the enterprise managers, who were centrallyinvolved in the implementation of the privatization program. Our paper considersthe objectives of all three agents, i.e., the local government leaders, the enterprisemanagers, and the employees, in determining the distribution of employee share-holding in China’s privatized TVEs. By analyzing the determinants of employeeshareholding in this broader context, the highly skewed pattern of employee share-holding that has emerged in rural China can be best understood. We also examinethe implications of this pattern of shareholding for earnings inequality in ruralenterprises.4

The paper is structured as follows. The next section provides an analysis ofthe institutional path of TVE privatization based on in-depth interviews with localcadres and enterprise managers and surveys of enterprises and workers collected in1999 and 2000 from three counties in Jiangsu and Shandong.5 Section 3 reviewsthe pattern of employee shareholdings in our sample and Section 4 sketches amodel of share holding determination that incorporates both the choices of theemployee and the objectives of the local leaders and the enterprise managers. Theempirical results are reported in Section 5. The impact of the distribution of shareownership on earnings is presented in Section 6 and we provide brief conclusionsin Section 7.

3 For example, commenting on the emergence of employee share ownership in postprivatizationCentral and Eastern Europe, Reilingh (1997, p. 12) states that “in a context of growth of incomeinequalities, falling real wages—when they are paid at all—and increasing poverty, employee ownershipcould play an important role in partly compensating the costs that the reforms have entailed for a largeproportion of employees, and more generally in promoting economic democracy and creating a newbasis for redistributive justice.” Therefore, share ownership by employees has been prominent in manyparts of Central and Eastern Europe (Uvalic and Vaughan-Whitehead, 1997). For its incidence in otherdeveloping countries, see Ramanadham (1995) and Leiberman (1994).

4 Although ownership of shares by employees is one of the most common features of privatization intransition economies because it reflects the concerns for distributional equity, the economic implicationsof this ownership form remain highly controversial (Uvalic and Vaughan-Whitehead, 1997). Whileimportant, the effects of employee share ownership in rural China on enterprise performance lie beyondthe scope of this paper.

5 Besides in-depth interviews with local cadres and enterprise managers, quantitative data werecollected from surveys of 45 enterprises and over 1000 employees in the three counties. Details of thefield sites follow.


2. THE PROCESS OF PRIVATIZATION IN JIANGSU AND SHANDONG

The privatization wave in rural China in the mid-late 1990’s was precededby a series of property rights changes. As early as the mid-1980’s, China hadexperimented with the conversion of collectively owned enterprises to sharehold-ing cooperatives (SCs) in Zhouqu township in Shandong and Baoan township inGuangdong (Lu, 1997). In the early 1990’s, local governments introduced variousreforms that gave increased autonomy to TVE managers to address the problems ofmanagerial incentives (Chen and Rozelle, 1999). After Deng Xiaoping’s southerntour in 1992, a series of new measures were introduced to reform China’s bank-ing systems, the ownership structure of SOEs, and to promote the private sectoreconomy. In consequence, many of the advantages that TVEs had enjoyed in thepartially reformed economy of the 1980’s disappeared.6 Added pressures on TVEscame from a slowdown in the macroeconomy and posed problems for many TVEsthat had invested heavily in the 1993–1994 period and financed their investmentlargely by bank loans. Overall, the TVE sector saw a slowdown in the growth ofoutput and employment that was accompanied by declining profitability and risingdebt-asset ratios during the 1990’s. Reforming the ownership structure of TVEswas deemed necessary for reversing these trends, and the focus was put on makingTVE managers fully responsible for their decisions, ending government interven-tion, and relying more on risk-bearing capital to finance the sector’s expansion.The reform process was further accelerated when the 15th CPC National Congressin 1997 endorsed the program of grasp the large and release the small (zhuadafangxiao), under which most medium- and small-scale public enterprises wereto be privatized. The Ministry of Agriculture estimated that, by the end of 1998,about 80% of all TVEs had been either converted to SCs, shareholding companies,partnerships, or proprietorships, or had been reformed through merger, leasing,collateral contracting, or bankruptcy (Yuan, 2000).

This latest phase of privatization is analyzed in this paper, based on informationgathered from in-depth personal interviews with enterprise managers and localcadres at the county, township, and village levels in three counties in Jiangsuand Shandong. These two provinces, which constitute the heartland of the ruralcollective sector,7 have been relative latecomers to the privatization process sothat the changes implemented in the mid- and late-1990’s offer a more dramaticexample of reform during this period.8 Jiangsu and Shandong are both located

6 TVEs enjoyed some tax advantages during the early days of reform. For example, the averageincome tax rate on TVEs was 21% compared to 29% for SOEs in 1992. This advantage was eliminatedby the 1994 tax reform that subjected all enterprises to a flat 33% income tax rate.

7 Jiangsu and Shandong produced about 20 and 14% of the total revenues of China’s TVEs, respec-tively, in the early 1990’s (NBS, 1993, p. 398).

8 In analyzing a case study in southern Fujian, Chen (1999, p. 61, emphasis in original) writes that“there is no de facto privatisation occurring in the course of Jinjiang’s industrialisation and development,partly because local governments had few collective enterprises available for contracting or leasing toindividuals to start with.” This stands in sharp contrast to the situation in Shandong and Jiangsu in themid-1990’s.


on the eastern coast and had the second and third largest provincial economiesrespectively in China in 1998.9 In terms of per capita income, the three countiesin our sample (Penglai and Yanzhou in Shandong and Wujin in Jiangsu) are abovethe national average and also above their respective provincial means. However,the income levels of the three counties differ significantly, with Wujin having thehighest income level and Yanzhou the lowest.10

Our interviews indicate that improving managerial incentives was an overridingconcern of local leaders in the three counties. In all three counties, the primaryeconomic goal of TVE privatization was to provide more incentives to managersby making them the majority owners of the privatized TVEs (changzhangchidagu).In each of the counties, there was a strong desire to privatize TVEs quickly so asto prevent further asset stripping and loss of managerial talent.11 Typically, TVEswere privatized over a 2-year period with the focus on township enterprises in thefirst year and on village enterprises in the second year.

To achieve the objective of transferring TVE assets to enterprise managers, twomain divestiture techniques were adopted.12 The first was selling the enterpriseoutright to its manager, or to a small group of senior employees led by the manager.Usually this method was used to privatize small enterprises. The net value ofenterprise assets was assessed by the local government’s assessment agency andmanagers were typically asked to pay 70–90% of the assessed value. The actualpurchase price was usually determined through negotiation between the buyer,typically the original manager, and the local government. In a few rare instances,the price was determined through public auction. Payments were in installmentsusually spread over a 3-year period.

The second method, called xianshou hougu, involved selling the enterprise to alegal person, usually represented by the original enterprise manager, who then reor-ganized the enterprise into a shareholding company. This method was used to priva-tize most of the larger enterprises. To entice buyers and ensure a speedy sale, sharesrepresenting up to 30% of the net value of the enterprise, based largely on the assess-ment of the township government’s assessment agency although the value was sub-ject to some negotiation, were offered for “free distribution.” However, free shareswere distributed only to those who also purchased shares. In other words, buyers ofenterprises were given up to 30% discounts. The enterprise manager was given the

9 The provinces have above average GDP per capita levels. For example, in 1998, annual averageper capita GDP was 10,050 yuan in Jiangsu and 8128 yuan in Shandong with the national averagebeing 6404 yuan. See Shandong Tongji Nianjian (Statistical Yearbook of Shandong), (1999, p. 427).

10 The average annual net income of peasants in Wujin was 5034 yuan per peasant in 1998, comparedto a provincial average of 3377 yuan in Jiangsu and a national average of 2162 yuan (Statistical Yearbookof Jiangsu, 1999). The average annual net income of peasants was 3308 yuan in Penglai and 3222 yuanin Yanzhou, compared to a provincial average of 2453 yuan in Shandong (Statistical Yearbook ofShandong, 1999).

11 For more details, see Ho et al. (2000).12 Other privatization methods include leasing, merger, bankruptcy, trusteeship, and managerial

contracting. For the details of these methods, see Ho et al. (2000).


responsibility of raising funds for the rest of the net value of the enterprise, againusually to be paid in installments over a 3-year period. Therefore, enterprise man-agers were able to decide, depending on their own personal financial situations andtheir assessments of the enterprise, how many of the shares to buy themselves, howmany to sell to others, and to whom to sell. However, the manager’s decision on thesematters was usually made in consultation with, or jointly with, the local govern-ment although the degree of government involvement varied among the threelocalities.

When shares were sold to employees, free shares were distributed usually inproportion to the shares purchased. To offer greater incentives to the managerialand technical staff, we were told that the allocation of purchased, and hence free,shares was often rationed, with senior managers, sales, and technical staff permittedto purchase more shares than production workers. In many enterprises, migrantworkers were not eligible to purchase shares, and in some enterprises local workerswere also not given the opportunity to purchase shares. Unlike managers, who wereallowed to pay for their shares in installments and use working capital and retainedprofits to finance their purchase, other employees were usually required to paycash for their shares, typically financed by personal savings or money borrowedfrom relatives and friends. In one enterprise, shares were distributed to workers tocompensate them for unpaid wages.

As a result of these divestiture procedures, the privatization of TVEs in all threecounties led to a high level of concentration of shares in the hands of management.Of the 45 enterprises surveyed, 39 were privatized and 6 remain government owned.Of the 39 privatized TVEs, only 16 had sold shares to their employees. In 33 of theprivatized enterprises, the manager or the managerial group, i.e., the manager plusother board members, held 50% or more of the shares. Employees were majorityshareholders in only 6 of the privatized enterprises. Indeed, for all 39 privatizedTVEs, 77% of the shares were held by managers and other board members, 17.9%by employees, 2.9% by local governments, and 1.7% by private investors fromoutside the enterprise (Table 1).

In general, employee share ownership was found to be more prevalent in largerenterprises and in the lower income counties. While cadres in lower income town-ships also stated in their interviews a preference for a privatization process thatwould result in a high degree of ownership concentration, they appeared to haveexperienced greater difficulties in achieving the desired outcome. Their failureto achieve a more concentrated share ownership in the hands of managers seemsto have been caused by limited wealth among managers in these localities. Withmanagers of large enterprises in the less developed counties unable to afford tobuy a dominant share of the enterprises, the government would have had to giveaway a significant amount of enterprise assets to managers if they were to becomemajority owners.13 However, while local governments were willing to provide

13 The local government could avoid such a giveaway by extending credit to the managers. However,such an arrangement does not solve the problem of asymmetric incentives on the part of managers.


TABLE 1Descriptive Statistics and Ownership Structures of the Enterprise Sample

Privatized TVEs

All Penglai Yanzhou Wujin Nonprivatized TVEs

No. of enterprises 39 11 10 18 6Employment 242 246 291 205 423(employees) (135.2) (120.7) (156.3) (117.7) (296.1)Assets 1,374.6 1,565.8 1,610.8 1,065.9 2,149.3(10,000 yuan) (1,590.8) (1,697.1) (1,882.9) (1,190.9) (2,268.0)

% of shares held byManagers 52.6 54.3 39.6 60.1 0.0Other board members 24.9 18.6 17.6 34.7 0.0Employees 17.9 23.5 32.4 3.6 0.0Local government 2.9 0.0 8.0 1.6 100.0Others 1.7 3.5 2.4 0.0 0.0

Note. The figures in parentheses are standard deviations.

significant discounts, typically up to 30% as discussed above, they were also un-willing to extend any further discounts given their revenue objectives. In thesecases, governments accepted a more diverse ownership structure with more sharesowned by workers. Concerns over revenue also resulted in a few large, profitableenterprises remaining under the ownership of the local government, for example,the 6 nonprivatized enterprises in our survey (Table 1).

This brief review of the privatization process illustrates the institutional contextwithin which ownership of shares by employees must be examined. Specifically,the privatization process placed significant limits on the ability of employees toparticipate and the purchase decisions of individual employees were made withina set of institutional constraints. Hence, a highly skewed distribution of shareownership among employees arose. In the next section, we document this out-come and provide evidence from employees on the factors affecting their sharepurchases.

3. OVERVIEW OF EMPLOYEE OWNERSHIP IN THE SAMPLE

Our analysis of employee share ownership is based on data gathered from the39 privatized TVEs. Of the 39 enterprises, 2 were privatized in 1994, 17 in 1996,17 in 1997, and 3 in 1998. All were sold primarily to enterprise insiders, i.e.,managers and workers. All enterprises were engaged in industrial production withmost producing light consumer goods. They were relatively large in terms of thenumbers of employees and the values of fixed capital assets. Table 1 providesdescriptive statistics of the enterprises. From each enterprise, we gathered data onprofitability, ownership structure, and the managers’ views on enterprise objectives


and constraints.14 Using a questionnaire, we surveyed approximately 25 employeesin each enterprise, mainly production workers but also some technical, sales, andmidlevel managerial personnel, to gather information on such variables as the levelof wages, bonuses, interest and dividend payments received, the value of sharesowned, various personal characteristics, such as age, sex, education, and seniority,and the main reasons why an employee did or did not hold shares.

As a first step, we compute descriptive statistics of employee shareholdings us-ing the information obtained from the employee survey.15 As indicated in Table 2,the distribution of employee share ownership is highly uneven; only about 33%of the employees in the sample held shares. The average value of shareholdingswas 3812.8 yuan for all employees and 11,649.0 yuan among all shareholders withrespective Gini coefficients of 0.874 and 0.615. The range of share values amongshareholders was 500 to 320,000 yuan. The distribution of employee share hold-ings appeared skewed towards socially more advantaged groups, more powerfulindividuals, and wealthier employees. Specifically, the between-group ratio of theshare values based on the entire sample was 3.3 to 1 between men and women,8.0 to 1 between local and migrant workers, and 3.3 to 1 between managerial staffand production workers. Moreover, ranked by family income, the value of sharesowned by the employees who were among the top 20% of the sample was 6.4 timesthat of the mean value of employees who were ranked among the lowest 40% offamily income.

To examine the reasons why an employee chose to buy or not to buy shares,employees were asked to identify the most important factor among a number ofconsiderations that may affect the decision to hold shares. Among shareholders,46.2% reported that their main motive in buying shares was to increase their in-come, 41.7% to help their firms, 3.4% to reduce the risk of being laid off, and 7.2%because the firm required the employees to buy shares. The motive to help theirfirms can be interpreted as an expression of the employees’ concerns about job se-curity. For nonshareholders, 73.6% responded that the main reason for not holdingany shares was that the opportunity had not been offered to them, 3.9% respondedthat they considered investing in the firm too risky, 13.2% answered that they had nomoney to invest, and 0.2% said that they did not trust the manager. These responsessuggest that, while conventional economic factors, such as income, job security,and risk, played an important role in the share ownership decision of employees,

14 Enterprise data were obtained from enterprise records. However, the employee data gatheredin the questionnaires were based on the recall of employees. Since memories are subject to errors,the employee data are probably less reliable. However, a comparison of the earnings reported byemployees with historical wage data obtained from enterprise payrolls suggests that the data gatheredfrom employees are reasonably accurate.

15 The manager and senior managers who owned, on average, about 77% of privatized enterprisesin the sample did not participate in our survey. Therefore, our discussion in the remaining section andthe analysis of share holdings determination in the next section are restricted to the distribution ofshare ownership between the employees who are predominantly production workers although someare midranking personnel.


TABLE 2The Distribution of Share Ownership over the Employee Sample

Total Shareholder Nonshareholder

No. of employees 883 289 594(%) 100.0 32.7 67.3Mean value of shares 3,812.8 11,649.0 0.0

(yuan/employee)Standard deviation 17,402.9 28,912.1 —Minimum 0.0 500.0Maximum 320,000.0 320,000.0CV2 20.83 6.16Gini coefficient 0.874 0.615 —

Between-group differentials in shareholdings

(1) Male Female The ratio of male to femaleMean value 5,440.6 1,638.1 3.3(yuan/employee)

(2) Local resident Migrant The ratio of local to migrantMean value 4,024.9 500.0 8.0(yuan/employee)

(3) Managerial staff Production worker The ratio of managerial toproduction workers

Mean value 7,605.8 2,339.8 3.3(yuan/employee)

(4) Top 20% of Bottom 40% of The ratio of top 20% tofamily income family income bottom 40%

Mean value 12,491.7 1,949.1 6.4(yuan/employee)

Note. The statistics presented in this table are derived from the employee survey for 39 privatizedTVEs. The value of shares, dividends, and total earnings are measured in 1998 current yuan.

their choice was also constrained by enterprise and local government policies onownership of shares by employees. Employees of some profitable enterprises mayhave been denied the opportunity to purchase shares while employees in some lowprofit and high-risk enterprises may have had shares forced on them. However,in our sample, the incidence of exclusion outweighed that of involuntary sharepurchase. To examine more systematically the determinants of share ownershipamong employees, we sketch a model of share determination in the next section.

4. A SIMPLE MODEL OF SHARE DETERMINATION16

The accessibility of share ownership varies over individual employees largelyas a result of factors such as whether or not shares are sold to employees, who is

16 The purpose of this section is to provide an analytical framework to identify the major determinantsof share holdings by employees not to develop a theoretical model of the entire process of TVEprivatization.


eligible for share purchase, and at what prices. While the decisions of individualemployees are the focus of the share determination model, to understand fully theprocess we must also take into account variables that reflect the institutional contextwithin which share purchase decisions are made. Therefore, before analyzing theshare purchase decisions of individual employees, we specify the constraints onemployee participation given by the privatization policies.

Assume that the local leader decides to sell an enterprise exclusively to theenterprise insiders, the manager, and the employees. The leader and the managerdetermine jointly the ownership structure of the enterprise after privatization bychoosing the percentage of shares to be held by the manager, Sm , and, conse-quently, the supply of shares to the employees, 1 − Sm . Both parties are interestedin maximizing the profits of the enterprise because this results in more tax revenuefor the local leader and generates higher returns to the investment of the manager.The postprivatization profit function of the enterprise is assumed to be increasingin the effort of both the manager and of the employees. Each is assumed to bepositively correlated with the respective party’s share ownership. Given the sym-metric relation in the division of share ownership between the manager and theemployees, we normalize the effort supplies of employees to unity. Thus, the profitfunction is increasing in Sm . However, the effect of Sm on profits is decreasing inthe weight placed on the work incentive of the employees relative to that of themanager, denoted as α.

In addition to the leader’s desire to maximize profits, the choice of the degreeof managerial share concentration is affected by two other factors. The first is theconflict of interests between the local leader and the manager over the sales priceof the enterprise, P ≥ 0. While the leader seeks to maximize the proceeds fromselling the enterprise, the manager wants the sales price to be as low as possible.To entice the manager to buy more shares, the leader has to reduce the sales price.Hence, we assume that the sales price, P , is decreasing in Sm . The second factoraffecting the choice of ownership structure is the manager’s wealth constraint,Sm P ≤ Wm , where Wm is the wealth of the manager. Sm is assumed to be chosenjointly by the leader and the manager to maximize the sum of the postprivatizationprofits of the enterprise plus the proceeds from selling the enterprise subject to themanager’s wealth constraint. The optimal degree of managerial ownership, S∗

m , is afunction of α and Wm , i.e., S∗

m = S∗m(α, Wm); it is decreasing in α and increasing in

Wm. Intuitively, S∗m is lower if the leader and the manager are more concerned about

incentives of the employees and/or regard share ownership to be more importantfor eliciting the effort supplies of employees, as would be indicated by a highervalue of α. S∗

m is also lower if Wm is lower because, with a lower Wm , a higherdegree of managerial ownership concentration has a larger negative effect on thesales price and, consequently, on the proceeds from selling the enterprise. OnceS∗

m is chosen, the supply of shares to the employees is given by (1−S∗m).

As indicated in our field survey, the accessibility of share ownership to employ-ees is determined not only by the degree of managerial ownership concentration


but also by the characteristics of an employee, such as position in the enterprise,residential status, and gender. The accessibility of share ownership varies overindividual employees within the enterprise with the more powerful agents able toacquire shares at more attractive terms.17 Thus, these institutional constraints areassumed to affect the unit cost of a share purchased by employee i , Ci . Hence, Ci

is a function of S∗m and of the characteristics of employee i , Ei . Therefore, Ci =

Ci (S∗m , Ei ) is increasing in the degree of managerial ownership concentration; it

is lower for managerial personnel and male employees and higher for migrantworkers.18 Having formulated the institutional constraints facing the employees,we turn to model the share purchase decision of employee i . Let si denote the num-ber of shares purchased by i and Ui the utility of employee i . Ui is assumed to be anincreasing function of si for any expected rate of return to share holding, Is , giventhe benefits of job security associated with share ownership, Ji , the risk preferenceand the perceived risk associated with share purchase, Ri , and the forgone return tothe alternative investment, IAi . Thus, Ui is specified as Ui = Ui (si ; Is , Ji , Ri , IAi ),where Ui is increasing in both Is and Ji , and decreasing in both Ri and IAi . Em-ployee i chooses si to maximize the utility function subject to a wealth constraintformulated as Ci si ≤ Wi , where Wi is the wealth of employee i . The optimal sharepurchase derived from the employee’s optimization program is written as

s∗i = f (Is, Ji , Ri , IAi , Ci , Wi ). (1)

s∗i is positively related to Is , Ji , Wi , and negatively related to Ri , IAi , and Ci . The

economic intuition of this functional relationship and these comparative static ef-fects is straightforward. Substituting Ci as a function of S∗

m and Ei in (1) and S∗m as a

function of α and Wm , we obtain the following reduced form shareholding equation

s∗i = f (Is, Ji , Ri , IAi , Wi , Ei , α, Wm). (2)

With respect to the additional arguments in (2), s∗i is increasing in α and decreasing

in Wm, because s∗i is decreasing in Ci , which is positively related to S∗

m , and S∗m

is decreasing in α and increasing in Wm , s∗i is higher for managerial personnel

and male employees and lower for migrant workers. The reduced form equationof shareholding determination in (2) identifies the major factors that shape the

17 As pointed out by Alexeev (1999), privatization in transition economies is essentially a contested,political process. This political nature of privatization is reflected not only in the division of publicassets between the manager and the employees but also in the distribution of share ownership among theemployees. However, one could argue that managerial personnel and local residents should be offeredmore shares at more attractive terms than were production workers and migrant workers, respectively,because the former group had contributed more to the development of the enterprise prior to theprivatization.

18 For the sake of tractability, we ignore the effect of direct rationing on share purchase. We use theunit cost to incorporate supply-side factors into reduced form equations.


distribution of share ownership among the employees in newly privatized TVEs.Thus, it provides an analytical framework for the empirical investigation.

Assuming that the probability of an employee holding shares and the value ofthe shareholdings are determined by Eq. (2), we estimate the probability and thevalue of employee share holdings, respectively, by a probit and a tobit regression.Let y∗

1 denote the desirable number of shares held by an employee, and y∗2 the

desirable value of shareholdings. Now y1 is a binary variable that is equal to onefor a shareholder and zero for a nonshareholder, and y2 is the observed value ofshareholdings. Clearly, y∗

2 is a function of y∗1 . We define the relationship between

y∗1 and y1 by the following probit model,

y1 = 1 if y∗1 = δ′ X + ε > 0,

= 0 if y∗1 = δ′ X + ε ≤ 0,

and the relationship between y∗2 and y2 by the following tobit model

y2 = y∗2 if y∗

2 = φ′ X + u > 0,

= 0 if y∗2 = φ′ X + u ≤ 0,

where X is a vector of the explanatory variables that affect the employee’s sharepurchase decision, as identified by Eq. (2), δ and φ are the vectors of parametersto be estimated, and ε and u, a monotonic transformation of ε, are the randomdisturbances.

The variables in Xi are defined as follows. The proxy variable for the expectedfinancial returns, Is , is profits per unit of capital assets prior to privatization becausethe expected return to shareholding is assumed to be positively correlated with theprofitability of the enterprise in the recent past. Four variables are introduced tomeasure the benefits of job security, Ji . The first is a dummy variable set equal to oneif the manager considered that the profits of the enterprise would increase if 10%of the workers were laid off, and zero otherwise. The higher is the likelihood thatthe enterprise might downsize its workforce, the higher is the employee’s desire tobe an employee shareholder in order to improve job security. The second variableis the proportion of migrants in the workforce of an enterprise; this serves as anindicator of the availability of alternative employment in the local labor market. Thehigher is the share of migrant workers, the higher is the demand for labor relative tosupply in the local market and, consequently, the less concern the employee has forjob security at the existing enterprise. For given enterprise characteristics, concernover job security may vary over individual employees. For example, employeeswith longer tenure have accumulated more firm specific human capital and areexpected to care more about their employment with the enterprise. In contrast,employees who have more education, and hence more general human capital mayhave better chances of finding a job elsewhere than those with less education.Thus, variables for an employee’s seniority and education, measured by years of


employment with the enterprise and years of schooling, are introduced to capturejob security effects, respectively.

The proxy variables for risk preference and perceived risk, Ri , include thecharacteristics of individual employees likely to affect risk preference, such asage, education, and family income, and a variable measuring financial uncertaintyfor shareholders. Younger, wealthier, or more educated employees are usually lessrisk averse than older, less wealthy, or less educated employees. Hence, the formergroup is expected to purchase more shares. We measure financial uncertainty forshareholders by the standard deviation of profits per unit of assets (SDPA) of theenterprise during the period from 1988 to 1998.19 The family income variable isintroduced also as a proxy variable for an employee’s wealth, Wi . The incomevariable is calculated as total family income from all sources in 1998 and consistsof income earned by all the members of a family, including both agriculturaland nonagricultural income. To avoid the problem of reverse causality, dividendearnings are subtracted from this variable.20

The position, residential status, and gender variables measure an individual’saccessibility to employee shareholdings and represent the influence of differenttypes of employees within the enterprise. The position variable is a dummy variablethat is set equal to one for managerial-level personnel and zero for other types ofemployees. An employee’s residential status is measured by a dummy variable setequal to one for a rural migrant and zero otherwise. The gender dummy is set equalto one for a male and zero for a female. We have no information on the returns toinvestment alternatives to shareholding. Since the vast majority of rural individualsdeposit their savings in banks, we assume that the interest rates on deposits, i.e.,the returns to alternative investment, are constant over this single cross section ofemployees in the sample.

The concern about work incentives for employees by the local leaders andmanagers, represented by α, is measured by a dummy variable set equal to onefor the enterprise whose manager ranked lack of effective incentives for workers,inability to discipline workers, or shortage of skilled workers as the top constraintamong 15 possible constraints affecting adversely the enterprise’s efficiency beforeprivatization. As indicated by Eq. (2), the shares of this type of enterprise are morelikely to be offered to employees in order to strengthen work incentives and toretain or attract skilled employees.

To control for the local leader’s desire to maximize sales revenue and the effectof managerial wealth constraints, we introduce four proxy variables.21 Two of these

19 To be precise, this variable is derived from the financial records of the enterprise in 1988, 1993,1995, and 1998.

20 The variables for individual employees’ characteristics were measured by their values in 1998,which is the same year used for the value of share holdings. We did not adjust these variables to takeinto account the fact that privatization occurred at different years for enterprise in the sample. Fromour interviews, we noticed that the shareholdings of employees were not constant after privatization,making it impossible to identify in which year individual employees purchase their shares.

21 Our data do not have information on the characteristics of the managers.


variables measure the size of the firm, including the total number of employeesand the net value of assets per employee prior to privatization.22 These proxiesare expected to be related positively to employee shareholding since a larger firmis likely to cause the local government to prefer more widely dispersed shareownership to meet its revenue objectives in the face of wealth constrained enterprisemanagers. The other two proxies are county dummies and a variable for the capitalconstraint facing the enterprise. The managers in less-developed counties face moresevere wealth constraints as a result of the lower income level of these localities.23

Among the three counties and other things being equal, the incidence of employeeshare holdings is expected to fall as we move from Yanzhou to Penglai to Wujinwith the per capita income level being the lowest in Yanzhou and the highest inWujin. The omitted category for location dummies is Wujin county. The capitalconstraint variable is a dummy variable for enterprises in which the managerranked the shortage of working capital as the most important factor constraining theefficiency of their enterprises prior to privatization. This variable serves as a crudemeasure of the manager’s ability to finance his acquisition of ownership rights inthe enterprise through channels other than family savings and is expected to havea positive effect on the incidence of employee share ownership. The descriptivestatistics of these variables defined above are presented in Table 3.

5. EMPIRICAL RESULTS

Maximum likelihood estimates of the probit and tobit regressions are reportedin Table 4. The two regressions fit the data very well. The probit model predictscorrectly about 88% of the shareholding incidence and has a pseudo-R2 of 0.473.The slope coefficients in both regressions are jointly significant at the 1% level.The marginal effects on the probability and the value of employee share holdingsare calculated using the parameter estimates of the respective model and the meanvalues of the variables involved.

The coefficient estimates of the two regression models are all supportive of theconjectures derived from the shareholding Eq. (2), except for the capital constraint.Specifically, we find that the probability and the value of shareholdings increasesin the profitability of the enterprise and that a 1% increase in profitability raisesthe probability of employee share purchase by 0.41% and the value of sharesheld by 64 yuan, which is 1.7% of the mean value of share holdings in the sam-ple. The probability and value of shareholding are higher in enterprises in which

22 While capital assets are a more direct measure of the size of the enterprise, conceptually, thisvariable was found to be statistically insignificant. This result may be due to the fact that the dataon capital assets are noisy. Hence, the number of employees and the net value of capital assets peremployee are introduced. Data on employment are usually more reliable than that on capital assets.

23 We interviewed the managers of two enterprises in which the employees were majority share-holders in a less-developed township in Yanzhou. They each invested about 100,000 yuan in theirenterprises using family savings and money borrowed from friends and relatives. They told us thatalthough they wished to acquire more shares, an investment of 100,000 yuan was all they could afford.


TABLE 3Summary Statistics of the Explanatory Variables for Employee Share Holdings

Total Shareholder Nonshareholder

Employees’ characteristicsAge 32.36 33.10 31.92(year) (9.06) (8.73) (9.24)Male 0.587 0.693 0.52

(0.493) (0.462) (0.50)Migrant 0.06 0.011 0.09

(0.24) (0.103) (0.29)Managerial staff 0.17 0.200 0.16

(0.38) (0.401) (0.36)Education 9.08 9.09 9.08(year) (2.19) (2.09) (2.25)Seniority 9.06 11.31 7.74(year) (5.82) (6.59) (4.87)Family income 13,588.6 12,806.7 14,051.7(yuan/year) (7,790.1) (7,793.4) (7,759.3)

Enterprises’ characteristicsProfits/assets −0.006 0.065 −0.048(yuan/yuan) (0.300) (0.149) (0.355)% of migrant workers 0.100 0.033 0.140

(0.152) (0.063) (0.173)Prospect of layoff 0.383 0.578 0.268

(0.486) (0.495) (0.443)Sd. of profits/assets 0.179 0.124 0.211(yuan/yuan) (0.300) (0.162) (0.354)Employment 243.3 287.7 217.0(employee) (132.4) (163.6) (101.5)Assets per employee 3.68 3.63 3.72(10,000 yuan) (2.86) (2.37) (3.11)Labor constraints 0.277 0.314 0.255

(0.448) (0.464) (0.437)Shortage of capital 0.181 0.093 0.234

(0.385) (0.291) (0.424)

% of the sample employees inWujin, Jiangsu 30.6 8.6 43.8Penglai, Shandong 36.2 39.8 34.0Yanzhou, Shandong 33.2 51.6 22.2No. of observations 753 280 473

Note. The statistics presented in this table are derived from the employee survey for 39 privatizedTVEs.

the likelihood of laying off workers is higher, lower in enterprises that have alarger share of migrant workers, positively correlated to the seniority of an em-ployee, and negatively correlated with education, although the effect of educationon the share value is insignificant. In an enterprise in which the manager considered


TABLE 4Probit and Tobit Analysis of Shareholding Determination

Probit regression Tobit regression

Dummy for shareholder Value of shareholdings

Dependent variable Coefficient Marginal effect Coefficient Marginal effect

Constant −7.293 — −189,751.0 —(−4.670)∗ (−6.257)∗

Profits/assets 1.988 0.406 24,379.2 6,377.6(6.605)∗ (3.539)∗

Prospect of layoff 0.785 0.160 10,968.0 2,869.2(5.653)∗ (3.757)∗

Seniority 0.067 0.014 1,054.7 275.9(4.882)∗ (4.087)∗

Education −0.072 −0.015 −686.0 −179.5(−2.211)∗∗ (−1.117)

% of migrant workers −0.077 −0.016 −633.6 −165.7(−9.698)∗ (−4.234)∗

Sd. of profits/assets −0.908 −0.185 −10,703.8 −2,800.1(−2.693)∗ (−1.620)∗∗∗

Age −0.021 −0.004 −192.1 −50.2(−2.390)∗∗ (−1.080)

Male 0.397 0.081 8,976.0 2,348.1(2.897)∗ (3.314)∗

Log family income 0.713 0.145 16,226.2 4,244.8(4.476)∗ (5.287)∗

Migrant −0.659 −0.135 −15,521.2 −4,060.3(−1.625)∗∗∗ (−1.805)∗∗∗

Managerial staff 0.437 0.089 8,727.3 2,283.0(2.421)∗ (2.632)∗

Labor incentives 0.847 0.173 10,536.7 2,756.4(4.782)∗ (3.248)∗

Employment 0.002 0.0003 3.31 0.87(2.598)∗ (0.343)

Assets per employee 0.007 0.001 1,077.9 281.9(0.232) (1.826)∗∗∗

Shortage of capital −0.803 −0.164 −1,723.2 −450.8(−3.329)∗ (−0.392)

Penglai −0.079 −0.016 12,027.0 3,146.3(−0.384) (2.802)∗

Yanzhou 1.359 0.278 19,571.6 5,119.9(6.474)∗ (4.525)∗

Percent correctPredictions 0.876 —Pseudo R2 0.473 —Wald test on zero slope 470.42 150.05p-value 0.0 0.0Observations 753 753

Note. The table presents the estimates of the probit and tobit regressions with t-statistics reported inparentheses and the marginal effects on the probability and value of shareholdings in separate columns.

∗ Significance at 1%.∗∗ Significance at 5%.

∗∗∗ Significance at 10%.


the employment level to be higher than justifiable so that the prospect of raisingprofits is high, the incidence of employee share ownership is 16% higher and thevalue of shares held is 2869 yuan, which is 78% of the mean value, larger.24 A1% increase in the proportion of migrants in the workforce, which is a proxy foralternative employment opportunities, would decrease the incidence of share pur-chase by 1.6% and the value of shares held by 165 yuan or 4.3% of the mean. A1-year increase in seniority raises the probability of share holdings by 1.4% andthe share value by 276 yuan or 7.2% of the mean. A 1-year increase in school-ing reduces the probability of share holdings by 1.5%, but its effect on the valueof shares held is not statistically significant. Evidently, expected financial returnsand job security are the most important factors in determining share purchase byemployees.

We also find that share purchase is negatively correlated with employee age andwith the standard deviation of profitability (SDPA), which is a measure of financialuncertainty. A 1-year increase in age reduces the probability of share purchase by0.4%, but the age effect on share value is not statistically significant. If the SDPAincreases by 1% per unit of capital assets, the incidence of share purchase falls by0.185% and share value decreases by 28 yuan or 0.7% of the mean. These resultsindicate that risk factors play an important role in share holding determination.

The positive sign and statistical significance of the variable of family incomeare consistent with the intuition that employees with less family wealth are morerisk averse and that family wealth imposes a budget constraint on share purchase.Quantitatively, a 1% increase in family income would increase the probability ofshareholding by 0.14% and the share value by 42 yuan or 1.1% of the mean sharevalue. This result indicates that privatization has tended to perpetuate inequalityas wealthier employees obtained more assets sold on attractive terms. We also findthat an employee’s position and residential status have significant impacts on shareholdings. The incidence and value of share holdings by managerial personnel are8.9% higher and 2283 yuan larger than those for other types of employees. Asexpected, share purchase by migrant workers is significantly lower than that bylocal workers. There is also a significant gender gap in share ownership in favor ofmen. The probability of share purchase by a male employee is 8.1% higher thanthe probability by a female employee, and the mean value of the shareholdings of amale is 2348 yuan higher or 61.5% of the mean value.25 Evidently, the redistributionof public wealth in the privatization of TVEs was biased towards the more powerful,and socially advantaged, individuals.

24 The strong positive effect of the prospect of layoff may also be attributable to the reluctance ofthe manager to invest in an enterprise that is in a poor financial situation as indicated by this variable.

25 Note that risk preference may also be a factor contributing to the gender gap in share purchase. InDong et al. (2001), however, we found that the gender gap in share ownership remained substantiallylarge after controlling for different risk attitudes between men and women. We attributed this unex-plained gender gap to the influence of the social force of Confucian patriarchy over the allocation ofentitlements and responsibilities in the Chinese society.


Regarding the work incentives for employees, the probability and value ofemployee share holdings are substantially higher, by 17.3% and 2756 yuan,respectively, in the enterprise in which the manager ranked a lack of effective incen-tives for workers or a shortage of skilled workers as the top constraint for raising thepreprivatization efficiency of the enterprise. This finding indicates that employeeownership may be an important incentive inducement in some enterprises.

Regarding the hypothesis with respect to the leader’s concern about sales revenueand the effect of managers’ wealth constraints, our results show that share purchaseincreases with the number of employees, as expected. This provides evidence thatthe local leaders’ accept greater employee share ownership when privatizing largeTVEs if this is necessary to meet their revenue objectives because managers arewealth constrained. However, although employment size has a significant positiveeffect on the probability of share holdings, its effect on the value of shareholdingsis not statistically significant. This result suggests that employee share ownershipis more widespread in larger enterprises but the value of shares held by a typicalemployee in these enterprise is not much higher than average. However, the patternfor the effect of assets per employee is reversed, indicating that the mean value ofshareholdings is somewhat higher in enterprises with larger capital-labor ratios,but the effect on the probability of share holding is insignificant.

As expected, share purchase varies by locality with share ownership being thehighest in Yanzhou, the county with the lowest income level. Specifically, theprobability and value of share held are 27.8%, and 5120 yuan, higher in Yanzhouthan in Wujin. While the incidence of share purchase in Penglai is not significantlydifferent from that in Wujin, the value of shares held in Penglai is 3146 yuan higher.These results are supportive of the conjecture that employee ownership is moreprevalent in the less-developed localities in which managers face more bindingwealth constraints.

Contrary to the conjecture that an enterprise suffering more from a severe capitalconstraint is more likely to sell shares to its employees, the estimate of the capitalconstraint variable in the probit regression has a negative sign and is significantat the 1% level. In particular, the incidence of employee share holdings is 15.7%lower in enterprises in which the manager considered the shortage of capital tobe the top impediment to operational efficiency. However, the effect of the capitalconstraint variable on the share value is not statistically significant. This is arather puzzling and counterintuitive result. One possible explanation is that thenegative effect of the capital constraint variable can be attributable to changesin the attitudes of financial institutions concerning the credit worth of the typeof enterprise resulting from the privatization of TVEs. A growing number of thebank managers preferred to lend money to private firms over public enterprisesin the late 1990’s (Park and Shen, forthcoming). This change in preference byfinancial institutions might have an adverse effect on the spread of employee shareownership. The enterprise manager may be hesitant to sell shares to the employeesbecause dispersed share ownership throughout the workforce might be perceived


as representing an incomplete reform process. Hence, the adoption of such anownership structure could make it difficult for the enterprise to obtain loans fromfinancial institutions. If this explanation is plausible, the estimates of the capitalconstraint variable suggest that the benefit of employee share ownership as ameans to raise investment funds from employees may have been counterweighedby its perceived negative effect on the enterprise’s access to credit from financialinstitutions.

6. IMPACT ON EARNINGS INEQUALITY

Our results indicate that the distribution of share ownership among the workforceis highly skewed, but does this matter economically?26 To answer this question, weexamine briefly the extent to which share ownership has increased earnings and theimpact that share ownership has on the distribution of earnings among the work-force. In our survey, about 75% of the shareholders received dividend paymentsin 1998. The rate of return to share ownership was quite respectable, 11.6% forshareholders who received dividend payments and 8.6% for all shareholders in thesample. Share purchase was apparently a profitable investment for the majority ofemployee shareholders, given that shares were generally obtained at discount andthat the interest rates on household deposits, the most widespread alternative formof savings for rural residents, were significantly lower.27 Dividend payments ac-counted for 17.6% and 14.1% of total earnings respectively for dividend receivingshareholders and all shareholders.

To obtain a general picture of the impact of share ownership on earnings andearnings inequality, we present in Table 5 the means and the Gini coefficients ofdifferent types of earnings before and after privatization.28 To facilitate comparison,the rescaled data for 1995 are to represent the preprivatization year while 1998 isused as the postprivatization year.29 All earnings are measured in 1990 constantyuan.30 To assess the statistical significance of changes in earnings inequality, wecompute the standard errors for Gini coefficients using the Jacknife technique.

26 In Dong et al. (2002), we examine the impact of employee share ownership on industrial relationsand democracy in these newly privatized TVEs. We find that employee share ownership has significantpositive effect on employees’ satisfaction, participation, organizational commitment, and supports forprivatization.

27 The interest rate on household demand deposits was 1.71 in 1997 and 1.44 in 1998; the interestrate on 3-month term deposits was 2.88 in 1997 and 2.78 in 1998 (China Statistical Yearbook, 1999,p. 627).

28 These statistics are calculated using the data obtained from the entire employee sample taken fromthe 39 privatized enterprises.

29 Since enterprises in the sample were privatized in different years, it is impossible to construct anearnings series for a single preprivatization year. Therefore, we have used the actual preprivatizationyear data and rescaled it where necessary, using the relevant provincial wage index, to obtain estimatesfor a single preprivatization year, namely 1995.

30 These are calculated using price deflators from the 1999 editions of the Jiangsu Statistical Yearbook(pp. 45–46 and 128) and the Shandong Statistical Yearbook (pp. 111–115).


TABLE 5Earnings and Earnings Inequality

Total earnings Wages and bonuses Dividends and interests

Before privatizationMean (yuan) 3,145.6 3,134.6 11.0Standard deviation (1,784.4) (1,785.4) (78.7)Share (%) 100.0 99.7 0.3Gini coefficient 0.255 0.255 0.980Standard error (0.009) (0.009) (0.004)90% C.I. (0.240, 0.269) (0.240, 0.269) (0.973, 0.986)Pseudo-Gini 0.255 0.205Share (%) 100.0 99.7 0.3

After privatizationMean (yuan) 3,942.3 3,754.5 187.7Standard deviation (3,034.8) (2,912.5) (566.1)Share (%) 100.0 95.2 4.8Gini coefficient 0.295 0.286 0.877Standard error (0.014) (0.015) (0.010)90% of C.I. (0.272, 0.318) (0.261, 0.311) (0.861, 0.893)Pseudo-Gini 0.282 0.554Share (%) 100.0 91.1 8.9

Note. The statistics presented in this table are derived from the employee survey for 39 privatizedTVEs. The postprivatization year is 1998 for all enterprises. The preprivatization year used is rescaleddata for 1995 (see footnote 28). Earning variables are measured in 1990 constant yuan.

Then, the Gini coefficient is decomposed by income sources using the proceduresgiven by Shorrocks (1982).

The earnings statistics from our sample indicate that the privatization of TVEsdid not result in wage depression. In fact, total earnings increased by 25.3% be-tween the two comparison periods, with an average rate of growth of 8.5% peryear.31 As a result of the introduction of employee shareholding, the share of prop-erty income, i.e., dividends and interest from shareholdings,32 rose from 0.3%of total earnings before privatization to 4.8% after privatization. The increase inproperty earnings accounted for more than 20% of the increase in total earnings.The Gini indexes show that the inequality in total earnings and wages rose by an

31 Note that changes in the level of earnings between the before- and after-privatization periods mayreflect both time and reform effects. As a reference for the general time trends in real wages, the realwage of TVE workers for China as a whole increased at a rate of 6.3% per year from 1990 to 1998(China Statistical Yearbook, various issues). While it is important to identify the determinants of therise of total earnings in the postprivatization year, the investigation of this subject is beyond the scopeof this paper.

32 Property earnings consists mainly of interest payments for the funds the enterprises had borrowedfrom their employees prior to the property rights reform and dividend payments for shareholdings byemployees after the reform.


appreciable amount in the postprivatization period. In fact, over the short period1995 to 1998, the Gini coefficient for total earnings increased remarkably from0.255 to 0.295, or by 15.7%.33 This change is statistically significant at the 10%level because the 90% confidence intervals of the Gini indexes for the two peri-ods do not overlap. The inequality in the distribution of property income amongemployees, as measured by the Gini coefficient, fell noticeably in the postprivatiza-tion period since more employees received this form of payment after privatization.However, as the pseudo-Gini indicates, the distribution of dividend and interestpayments was skewed towards those with higher total earnings.34 The relative im-portance of nonlabor income in explaining total earnings inequality rose sharply;its share in total income increased from 0.3% before privatization to 8.9% afterprivatization. Clearly, inequality in share ownership distribution has become animportant source of the rising income inequality in postprivatization rural China.

7. CONCLUSION

This paper has investigated employee share ownership that has emerged fromthe privatization of TVEs in Jiangsu and Shandong, two provinces that were in theheartland of the collective sector in China. Our analysis shows that the privatiza-tion process resulted in a high concentration of share ownership in management,enterprise managers plus other board members, in our sample of TVEs in the twoprovinces. Regular employees did own shares in 16 of the 39 privatized enter-prises, but, even in these enterprises, the distribution of these shares was highlyskewed towards those who were wealthier, male, local residents, and in managerialpositions.

We examine in detail the determinants of share holdings by employees. Ouranalysis indicates that employee decisions to purchase or not purchase shares areinfluenced by expected financial returns, job security, risk preference, and familywealth. In addition to considering these standard factors, we analyze privatizationwithin a specific institutional framework. Privatization is a politically determinedprocess in which local governments and enterprise managers determine the con-straints under which employees make their share purchase decisions. In Shandongand Jiangsu, the process was driven by local leaders’ desire to privatize enterprisesby selling a dominant share ownership to managers, subject to their concern forrevenue objectives. Enterprise managers were heavily involved, not simply in buy-ing shares, but also in selling shares to other individuals. As a result, importantdeterminants of employee share ownership are the local leaders’ preferences formanagerial buy-outs relative to their concern for improving work incentives ofemployees, the leaders’ revenue objectives, and the wealth constraints of mana-gers. The political nature of the privatization process is further evidenced by our

33 Note that our sample is truncated in that senior managers’ earnings are not part of the sample.34 The pseudo-Gini coefficients for wages and bonuses and for dividends and interests are calculated

using the rank of individual i in the distribution of total earnings.


findings that employees’ positions within the enterprise and within the communityaffected their ability to participate in share ownership. The more powerful werebetter able to claim shares. The effect of this pattern of shareholding is to increasethe degree of earnings inequality within the enterprise. Our results show that in-equality in the distribution of share ownership became an important source of therising income inequality in China during the postprivatization period.

As a final caveat, our sample is relatively small and restricted to only twoprovinces in a country that has significant regional differences. Although recent,our analysis is only a snap shot of a rapidly changing institutional structure in ruralChina so that our results must be considered from this perspective. Nevertheless, theevidence presented in this paper indicates that changes are clearly underway in ruralChina. Analyzing these changes is of considerable importance for understanding abroad range of issues, including the dynamics of institutional change and patternsof income inequality in China’s postprivatization rural economy.

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