Shares versus Residual Claimant Contracts: The Case of Chinese TVEs

This paper uses a national survey of 200 Chinese town and village enterprises (TVEs) from 1985 to 1990 to explore empirically the effect of contractual arrangements on the performance of enterprises under Chinese institutional conditions. A theoretical model that emphasizes a potentially important role for local government effort in a situation of double-sided moral hazard is developed to explain why the share profit system may produce better incentives than the quota profit system. The paper shows that, from a profit maximazation perspective, the trend away from share profit contracts to quota profit contracts among Chineses TVEs in the late 1980s may have been premature.