Decentralization, local protectionism, and home court bias

Economic federalism has been credited for China's rapid economic growth. However, this policy can also induce local protectionism that leads to economic inefficiencies. In this chapter, we use judicial localism as a proxy for the extent of local protectionism. We document that shareholders react less negatively when a firm is sued in its local court. We also show that a non-local firm is more likely to appeal when it receives an unfavorable verdict in the first-run trial, implying an unfair judgment. Taken together, our findings suggest there is a systematic home court bias in corporate litigation in China. Possible solutions to the home bias exhibited in courts include a rethink about how courts are financed and giving increased publicity to favoritism towards local litigants. Currently, courts are financed by cities and provinces and this leaves them open to local influence. Some changes in the way courts are financed could lead to less local bias. Greater publicity given to the prevalence of and the effects of home bias might lead to better conduct in the courts. While economic federalism has its benefits, prolonged local bias could lead to lower investment by foreign firms, less inter-regional trade, and a reduction in economic efficiency.