An important aspect of the conduct of business in China is the need to develop relationships and make facilitation payments in the form of entertainment and gift giving. We use three different methods to extract firms' relationship spending from their reported entertainment and travel costs, and evaluate whether this spending enhances their ability to respond and adapt to changes in the business environment – their strategic flexibility. We employ a real options approach that identifies strategic flexibility as the firm's ability to take advantage of increased uncertainty, measured as its value gain associated with increased asset volatility. We document that relationship spending is positively associated with strategic flexibility in a way that is both significant and economically meaningful, consistent with rent-seeking behavior under institutional voids. This relation is both independent of, and supplemented by, firms' political connections, and is unaffected by the important anti-corruption campaigns implemented in 2013. The relation is nonlinear, strategic flexibility declining at very high levels of spending, implying firms become over-embedded in their relationships consistent with path dependence theory. Our findings are supported by detailed robustness testing, including quasi-exogenous variation, an instrumental variable approach, a decomposition of political connectedness and the estimation of alternative specifications. Thus, we identify a new source of firms' strategic flexibility and, relatedly, an important benefit that firms derive from the associated spending. This might explain why such spending is resilient, persisting despite ongoing attempts by the government to restrict it.

We investigate firm corruption in China by extracting a measure of corruption from published financial statements and use this to demonstrate that corruption impacts the trading decisions of insiders. Specifically, we show that insiders in firms that are more corrupt trade more aggressively, and they are more willing to trade on their private information as evidenced by the increased informativeness of their trades, in respect of both purchases and sales. This link between firm corruption and trade informativeness is robust to the inclusion of a number of factors that are known to influence the informativeness of such trades, including trade characteristics, insider characteristics and the firm's information environment. We also consider the effect of the appointment of a new CEO or Chair. Overall, corruption related trade informativeness holds consistently for both purchases and sales. Finally, we show that this measure of corruption is robust to the inclusion of several alternative indicators of corporate misconduct.