Chinese state-owned enterprises (SOEs) have become quite profitable recently. As the largest shareholder, the state has not asked SOEs to pay dividends in the past. Therefore, some have suggested that the state should ask SOEs to pay dividends. Indeed, the Chinese government has adopted this policy advice and started to demand back dividend payments starting from 2008. Although we do not question the soundness of the dividend policy, the point we raise is whether those profits are real if all costs owed by SOEs are properly accounted for. Among others, we are interested in investigating whether the profits of SOEs are still as large as they claim if they were to pay a market interest rate. Using a representative sample of corporate China, we find that the costs of financing for SOEs are significantly lower than for other companies after controlling for some fundamental factors for profitability and individual firm characteristics. In addition, our estimates show that if SOEs were to pay a market interest rate, their existing profits would be entirely wiped out. Our findings suggest that SOEs are still benefiting from credit subsidies, and they are not yet subject to the market interest rates. In an environment where credit rights are not fully respected, dividend policy, though important, should come second and not first.

We wish to thank Hans Genberg, He Dong, and Matthew Yiu for helpful discussions and Angela Maria D'Uggento for offering her guidance to improve our sampling methodology. We acknowledge the useful comments provided by an anonymous referee, as well as by John Knight, May-Françoise Renard, Changwen Zhao, and by several other participants at the 2010 Asian Economic Panel meeting in Seoul. The views presented in the paper are those of the authors alone and do not represent those of the institutions with which they are affiliated.

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