We investigate the impact of state ownership structure and monetary supply shocks on asset prices and corporate policies. By primarily focusing on China's corporations, we show that the relationship between stock returns and capital investment varies significantly across state owned enterprises (SOE) and private owned enterprises (POE). In particular, a portfolio that longs low investment and shorts high investment firms earns an average annual excess stock return of 4% in the SOE sector. In contrast, there is no relationship between investment and expected returns in the POE sector. We show that the difference in return predictability across SOE and POE firms is driven by their differential exposures to the China monetary supply shock as SOE firms have easier access to bank loans. This makes the high investment SOE firms more able to raise debt in bad times and hence are less risky. We develop a dynamic model with SOE and POE firms facing different frictions in debt markets. The economic mechanism emphasizes that heterogeneous access to the debt market is an important determinant of equilibrium risk premiums across sectors with different state ownership.
