We analyze the effects of local government debt on the proliferation of zombie firms. With aggregated prefecture-level debt data and firm-level data from 2006 to 2013, the empirical evidence demonstrates that the local government debt significantly exacerbates the “zombification” of local firms, mainly through the credit-favoritism to state-owned enterprises and capital misallocation. Our analysis also shows that the magnitude of zombification effects is influenced by debt liquidity and the primary functions of local government financing vehicles.

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