Who determines Chinese firms' engagement in corruption: Themselves or neighbors?

•We test theories of firm corruption in the Chinese contexts.•The empirical analysis is based on the World Bank Enterprise Survey.•We identify three channels underlying “osmosis” of firms' engagement in corruption.•Firms' corruption is affected by their own past experience of bribing bureaucrats.•Firms' corruption is also affected by their neighbors' observed malfeasance.

We investigate the determinants of firm corruption and highlight contagious diffusion of firm corruption under mutual influences of firms' past corrupt history and between peers. The analysis finds that firms' decision-making on engagement in corruption can be affected vertically by their own past experience of bribing bureaucrats and horizontally by the contagion effects of neighbors' observed malfeasance, while there is substantial regional heterogeneity. Moreover, these horizontal contagion effects are nonlinear depending on the distance between neighbors. We also identify three channels underlying “osmosis” of corruption: firms' geographic networks, information exposure, and local marketization. The strongest contagion effect appears in the eastern region, indicating that petty firm corruption can develop into a systematic phenomenon. More practical anti-corruption policies call for cooperation in design and implementation across administrative areas.