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When a SpaceX cargo capsule docked with the International Space Station for the first time, in May 2012, company founder Elon Musk acknowledged that government funding, comprising half of SpaceX’s budget during the company’s first decade of operation, had enabled the moment. “Huge appreciation for @NASA, without whom we could not even have started, let alone reached this far,” Musk tweeted.
But government largesse is less welcome in China, suggests research by Chicago Booth’s Emanuele Colonnelli, Tsinghua University’s Bo Li, and Princeton’s Ernest Liu. They find that most investors—particularly those that post high returns—tend to shy away from government capital, perhaps because the potential costs of political interference may be considered greater than the potential benefits of the access it confers.
China’s venture-capital and private-equity markets are the second largest in the world, behind those of the United States, and the Chinese state plays a particularly active role in both. As of 2019, state-backed funds accounted for at least 70 percent of the money in private equity. The market comprises two main players: limited partners, which provide capital, and general partners, which deploy capital.
As a limited partner, the government provides several benefits. Most obviously, it has deep pockets. Partnering with the government can also accelerate regulatory approval, provide information advantages, and offer valuable connections in particular industries. But government partnership can also limit investment options and create mismatched incentives over how much risk to take and whether to stabilize or maximize returns.
A 2021 survey of general partners at private-equity and venture-capital firms in China indicates that they see some advantages to having investors with government ties but are wary of interference in investment decisions, among other things.
Colonnelli, Li, and Liu collected ownership information and performance data across most of China’s VC and PE ecosystems between 2015 and 2019 and ran an experiment with 688 general partners to explore how they think about government money. The researchers created profiles of hypothetical limited partners, some connected with the government, and asked the general partners to rate how interested they would be. To encourage accurate answers, they told respondents that their ratings would be used later to introduce them to real potential investors matching their preferred characteristics.
Most general partners said they preferred private funding over government capital. This preference was strongest among high-performing VC and PE firms with no government connections. But general partners that had some degree of government ownership did not discriminate against government-backed investors. Of general partners in China, 38 percent had some portion of government ownership; they performed more poorly than private operations.
The researchers also find that preferences for government capital applied unevenly across sectors. Investors that operated in industries such as real estate, mining, or insurance—in which the Communist Party is heavily involved—were more willing to accept capital from the government for the simple reason that political connections seem to be more valuable, the researchers conjecture.
“Nor is dislike for government the same at every level,” Colonnelli says. General partners were much more likely to accept money when it came from local governments, which are known to be important licensing gatekeepers in China. “But when it comes to provincial or central government agencies, the dislike is strongest,” he says. “You tend to get lots of political interference standing in the way of operations.”
In a follow-up survey, the researchers directly asked managers at investment firms their thoughts about working with limited partners with government ties. More than 350 general partners responded, pointing to interference in the investment process as the overwhelming problem with receiving government capital.
Despite the context of China’s financial markets, Colonnelli notes that these results raise questions about the value of public investment generally. Cities, states, and countries all strive to promote homegrown innovation and entrepreneurship. But given the reservations of many Chinese investment firms when it comes to accepting state money, “we may want to reconsider how much comes from the government,” Colonnelli says.
Emanuele Colonnelli, Bo Li, and Ernest Liu, “Investing with the Government: A Field Experiment in China,” Working paper, December 2022.
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