Does Enforcement of Intellectual Property Rights Matter in China ...

when the roles of formal financing channels are relatively small and narrow (very few large banks)
or virtually nonexistent (a lack of corporate bond market)?
Filling the financing gap are trade credit and various informal sources of financing. Some
examples of informal financing include funding from friends, family, and community, rotating
savings groups, underground financial institutions, and inter-corporate lending. On one hand, these
informal sources lack legally enforceable means to possess borrowers’ assets as security, thus their
payoff depends critically on the borrowers’ ability to generate cash flows. Poor enforcement of IP
rights can increase the probability and magnitude of appropriation by the borrowers’ competitors,
resulting in reduced expected cash flows. On the other hand, when the borrowers disclose
confidential information to the informal lenders, these lenders may divulge the information to a third
party including other competitors they have financed (similar to the venture capital situation
modeled by Ueda, 2004).
Firms in provinces with poor IP rights enforcement are therefore
discouraged to seek financing from informal lenders. These considerations, taken together, suggest
that there is a positive relationship between IP rights enforcement and firms’ financing from
informal sources (Hypothesis 2).
2.5 IP rights enforcement, R&D input, and R&D output
Better IP rights enforcement raises the expected payoff from investing in R&D. Thus, we
hypothesize that high tech firms in the provinces with better IP rights enforcement invest more funds
in R&D (Hypothesis 3). Firms in provinces with better IP rights enforcement receive greater
protection from patent infringement, therefore they are more likely to seek patent generation,
registration, and application. Thus we expect better IP rights enforcement increases the number of
patents generated by firms (Hypothesis 4A). Poor IP rights enforcement makes stealing of
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