We examine how hometown ties among local politicians affect capital allocation in China. We use a difference-in-differences design that relies on the exogenous replacements of city officials. Our results indicate that hometown ties between city party secretaries increase city-dyad investment by 10% and firm registrations by 1%. These effects are larger between distant cities and for the investment of small and private firms. Comparing the effects before and after the Chinese anti-corruption campaign, we provide nuanced evidence showing that, although hometown ties may entice the rent-seeking activities of officials, such activities may promote economic growth.

Audits are a standard mechanism for reducing corruption in government investments. The quality of audits themselves, however, may be affected by relationships between auditor and target. We study whether provincial chief auditors in China show greater leniency in evaluating prefecture governments in their hometowns. In city-fixed-effect specifications – in which the role of shared background is identified from auditor turnover – we show that hometown auditors find 38 percent less in questionable monies. This hometown effect is similar throughout the auditor’s tenure, and is diminished for audits ordered by the provincial Organizations Department as a result of the departure of top city officials. We argue that our findings are most readily explained by leniency toward local officials rather than an endogenous response to concerns of better enforcement by hometown auditors. We complement these city-level findings with firm-level analyses of earnings manipulation by state-owned enterprises via real activity manipulation (a standard measure from the accounting literature), which we show is higher under hometown auditors.