Abstract
We show that corruption affects negatively the performance of small entrepreneurial firms, which compete with corrupted industry peers. We exploit the Chinese anti-corruption campaign to establish causality and identify the channels through which corruption causes negative externalities. Small firms have lower sales growth in industries with high corruption, arguably because demand is diverted to the largest firms in their industries, which spend more in corrupting officials. Small firms also have higher financing costs in industries with high corruption and therefore invest less. Furthermore, corruption decreases the efficiency of labor and capital allocation and deters firm entry.