CHINAS MANAGERIAL LABOR MARKET formance, with managers of poorly performing firms being demoted more frequently than other managers. Moreover, we would expect both the method of selecting a new manager and the terms of the new managerial contract to be related to the principal's evaluation of he existing situation in the enterprise. We examine two main meth ods for selecting a new manager-appointment by superior and com- petitive auctions-and attempt to explain the choice of appointment method made by the industrial bureaus. Since the choice between these two methods is made by the industrial bureau, the basic princi- pal-agent relation is unchanged by the choice of managerial selection and should be seen as a choice made by the principal (the industrial bureau)in order to elicit the desired behavior from a class of potential Auctions, as noted above, serve to reveal information. Imagine that the industrial bureau, seeing that a firm is performing poorly, does not know whether the poor performance is due to bad management or to features of the firm beyond the manager's control. Then it might decide to use an auction, for the bidding process will reveal the identities of alternative potential managers, and the bids will re- veal their various estimates of the firms potential. Thus we might expect that the industrial bureau will tend to opt for auctions for firms that are performing poorly and appointment for firms that are In addition, the structure of the new type of contracts offered managers under the reforms might be expected to refect the perfor mance of the firm. Poorly performing firms might be put on a horter leash"by the industrial bureaus. In particular, larger security deposits might be required of new managers taking over such firms and shorter contract terms offered. Security deposits generate incen- tives for the manager, and they are needed more in poorly per for orming firms. A shorter contract term for poorly performing firms so serves both principal(bureau) and agent (new manager).It heightens the scrutiny of the manager and enables the bureau to dump poorly performing managers after a shorter time. but a shorter contract also reduces the risk for a new manager by not lock- ing him for a longer time into a firm that was performing poorly ecause of firm-specific reasons 1. Test of Relation of Performance to Contract Terms and Manager Selection To test whether or not Chinese bureaucrats in charge of selecting firm managers were influenced by the performance of the firms un der their managers, we estimated the relationship between various