Causes of the soft budget constraint: Evidence on three explanations

This paper conducts empirical evaluations of three recent theories of the soft budget constraint (SBC) using data from China's enterprise reform period. For enterprises with financial losses, we find that employment of nonproduction workers, investment with below-average rate of return, and distribution of excessive amounts of bonuses have all contributed significantly to the losses. In addition, there is no evidence that these factors decrease in response to financial losses. These findings support all three theories identifying political influence, creditor's lack of information and commitment. and insider control as causes of the SEC. (C) 1998 Academic Press.