*2.1. Why China?*

Emerging markets are prone to managerial discretion to a greater extent compared to in Anglo-American countries. Managers in these economies tend to manage funds inefficiently, which directly affects firm performance. Compared to developed economies, the extent of agency cost is different in emerging economies, specifically in China. Many researchers have used the proxy of agency cost based on either the managerial discretion or ineffective use of shareholder's funds.

We chose Chinese listed firms for this study because China's market for corporate control and the stock market mechanism is unique. Established in the early 1990s, the Chinese stock market was used as a vehicle to transform the "planned economy" to a "market economy." The Chinese Securities Regulatory Commission (CSRC hereafter) under the umbrella of the Chinese government made these reforms possible. Chinese listed firms rely heavily on internal financing, such as retained earnings, rather than external funding. The reliance on internal financing gives managers discretion to manipulate funds for self-empire building or investing inefficiently.

During the wave of recent privatization, about 60% of the Chinese market is still under the direct or indirect control of the state. The word corporatization is used instead of privatization by Lin (2001). He suggested that although the market for corporatization falls in the hands of the state, the firm's governance will be improved. The corporatization process has made it difficult for stakeholders to distinguish between state-held and non-state-held companies (Milhaupt and Zheng 2015). State control leads to more market power and easy access to external financing, which ultimately leads to a considerable amount of funds at the disposal of managers. Firms with concentrated state ownership behave differently when compared to non-state firms. For this purpose, the agency cost in state-owned institutions is much higher than in privately held firms. Clarke (2003) suggested that state-owned enterprises lack any clearly defined principles, which incites managers to fulfill their interest rather than the interest of the shareholders. Additionally, these managers have strong political backing, which makes them unaccountable for their actions. Therefore, as described by Ding et al. (2007), the performance of state-held firms falls well short of that of privately owned firms. Based on the argument above, we try to answer the research question, whether the ownership type affects the agency–performance relationship or not?
