Our results are robust after controlling for firm selection into better performing provinces and performing falsification tests for a sub-sample of firms located in Special Economic Zones (SEZs). We also address the issue of reverse causality, where improvements in the business environment, especially corruption levels, can be in response to firm outcomes. We exploit an institutional arrangement for revenue sharing between the Vietnamese central government and the provinces, using the rate of revenue sharing as an instrument for the overall measure of local governance. In the robustness tests and the IV regressions, we find that our general results still hold: better governance and business environment increases firm productivity.

There is a growing branch of literature that examines the effects of governance on firm performance but few have examined this relationship over time and in a developing country. The survey of the local governance indicators in Vietnamese provinces represents one of the few datasets on business environment and governance in a developing country collected over time. The closest study to our paper in terms of question and data is McCulloch et al. (2013). Using the enterprise survey and Provincial Competitiveness Index (PCI) in Vietnam over a 5-year period (2006-2010), McCulloch et al. (2013) examine how changes in provincial business environment affected firm investment levels. They find that firm investments are not affected by changes in the overall measure of business environment nor the individual aspects of business environment, with the exception of the transparency measure. Unlike our study that uses measures of productivity, the use of firm investments as a measure of firm outcome can be biased: outcomes such as investments and firm survival can be lumpy and difficult to observe in a short time period.<sup>5</sup> Dell et al. (2015) also examines the effects of local governance on firm performance by exploiting the different governance norms across two regions separated by a historical boundary. They employ a regression discontinuity approach to find that foreign companies are less likely to invest in historically bureaucratic areas.

The rest of the paper is divided into five sections. Section 2 provides a brief background to the provincial governance structure in Vietnam and the data. Section 3 describes the empirical methodology used in the paper. Section 4 presents the descriptive statistics and the results. Section 5 contains the robustness checks and the IV regressions. Section 6 concludes.

# 2 Background and data

## _2.1 Decentralization of business regulatory functions_

The main hypothesis of this paper is that local governance quality determines how national business regulations are interpreted and enforced, which will affect aggregate productivity through both individual firms’ productivity as well as the efficiency of resource allocation across firms. Vietnam’s decentralization of administrative tasks provides an ideal setting to test this hypothesis. Before the decentralization reforms began in 2004, the capital bore a large administrative burden as all approvals and negotiation of new projects were conducted in Hanoi irrespective of where the business was located (Schmitz, et al., 2012).

A key responsibility decentralized to the 63 provinces since 2004 is the ability to manage the development of the private sector. This decentralization devolved a lot of responsibilities to the provincial bureaucrats

> 5 Previous papers have looked at firm survival, investments, and growth. However, these outcomes can be modelled as endogenous choices based on firm productivity in models such as Levinsohn and Pakes (1994).

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