Abstract Using a unique setting in China, where the geographic distance between collective firms and local governments is highly persistent because of legal restrictions on land ownership and mobility, we investigate the role of government involvement in small firms. In our analysis of survey responses, we find that weaker government involvement, measured by greater distance from government, is associated with higher firm autonomy and reduced taxes, protectionism, and anticompetitive behavior. In our analysis of firm-level financial data, we find that distant firms have better operating performance, higher growth, and higher entry rates. We find similar results around exogenous government office relocations.

Models of political risk predict that increases in political uncertainty cause stock prices to fall, especially for politically sensitive firms. We use the event of the Bo Xilai political scandal in 2012 in China as an exogenous shock to identify the impact of political uncertainty on asset prices. We document that the Bo scandal caused a significant drop in stock prices, especially for firms that are more politically sensitive. Further analysis shows that the stock price drop is mainly driven by a change in discount rate, providing strong support for the existence of priced political risk.