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Protection or Expropriation: Politically Connected Independent Directors in China
Abstract
This paper empirically investigates politically connected independent directors among Chinese listed firms using 7,487 firm-year observations from the Shanghai Stock Exchange during the period of 2003 to 2012. We distinguish between privately controlled firms and state-controlled firms. We find that the value effect and incentives of appointing independent directors with political ties are shaped by a firm’s ownership structure. More exactly, Chinese listed privately controlled firms with a large fraction of politically connected independent directors tend to outperform their non-connected counterparts, due to the ease of access to external debt financing and more subsidies from the government. However, the appointment of politically connected independent directors also enlarges the magnitude of related-party transactions with the controlling party in listed privately controlled firms. In contrast, having politicians as independent directors does not help to add value to listed state-controlled firms, especially firms controlled by the local government, due to the expropriation of minority investors via more related-party transactions and more severe over-investment problems.
... Prior research have identified that board independence (Garcia Osma, 2008;Kang and Kim, 2012;Talbi et al;2015), CEO duality (Fama and Jensen, 1983;Millon et al., 2009), ownership structure (Shayan-Nia et al., 2017;Mellado and Saona, 2019;Piosik and Geng, 2019;Ghaleb et al., 2020) audit committees (Cheung and Chung, 2022), represent key dimensions of corporate governance aimed at mitigating REM practices. ...
... On the other hand, the proponents of the grabbing hand hypothesis (Shleifer and Vishny, 1998) support that political connections may increase the expropriation risk, as politicians may prioritise their own interests and divert business resources (Wang, 2015). Shleifer and Vishny (1994), Faccio (2006), argue that connected boards extract private gains through rent-seeking, which will destroy firm value and resulting in lower earnings quality. ...
... Larger firms may have fewer incentives to engage in earnings management, as they are subject to additional scrutiny from investors (Dechow and Dichev, 2002;Xie et al., 2003). However, other studies argue that managers of larger firms have more opportunities to manipulate earnings because of the large number of transactions they undertake and the complexity of their operations (Wang, 2015). So, we control for the effect of firm size, but we do not predict the direction of this variable. ...
... The impact of political connections on corporate sustainability disclosures is complex, with both positive and negative implications. Independent directors with political backgrounds bring valuable social capital and facilitate companies' access to government resources, fostering their business activities (Wang, 2015;Wang and Lin, 2017;Wang et al., 2019;Hu et al., 2020). In the Chinese context, these directors are associated with increased access to long-term debt financing and government subsidies (Wang, 2015;Wang and Lin, 2017;Hu et al., 2020). ...
... Independent directors with political backgrounds bring valuable social capital and facilitate companies' access to government resources, fostering their business activities (Wang, 2015;Wang and Lin, 2017;Wang et al., 2019;Hu et al., 2020). In the Chinese context, these directors are associated with increased access to long-term debt financing and government subsidies (Wang, 2015;Wang and Lin, 2017;Hu et al., 2020). However, their presence may lead to heightened government intervention in firms' operations (Wang, 2015;Hu et al., 2020), introducing political pressure that diverts attention from market-driven corporate goals (Xu and Liu, 2020;Yu and Chi, 2021). ...
... In the Chinese context, these directors are associated with increased access to long-term debt financing and government subsidies (Wang, 2015;Wang and Lin, 2017;Hu et al., 2020). However, their presence may lead to heightened government intervention in firms' operations (Wang, 2015;Hu et al., 2020), introducing political pressure that diverts attention from market-driven corporate goals (Xu and Liu, 2020;Yu and Chi, 2021). Considering the significance of CSR on the Chinese government's political agenda (Li and Guo, 2022), politically connected independent directors may influence companies to prioritize fulfilling their assigned political tasks, potentially promoting sustainability disclosure. ...
Purpose
This paper investigates the influence of political connections on sustainability disclosure in the context of China's Regulation 18.
Design/methodology/approach
The study employs a quasi-experimental approach, utilizing difference-in-difference (DiD) analysis, dynamic DiD and propensity score matching to analyze the effects of politically connected independent directors on sustainability disclosure following the implementation of Regulation 18.
Findings
Companies with politically connected independent directors show an improvement in sustainability disclosures after Regulation 18. This effect is stronger for firms facing high political pressure or lacking alternative political power. Additionally, the increase in value from sustainability disclosures compensates for the loss of politically connected independent directors, indicating a positive value impact of sustainability disclosures.
Originality/value
This study provides novel insights into the corporate disclosure policy in China by investigating the impact of politically connected directors on sustainability disclosure. Additionally, it sheds light on the limitations of political power and its substitution effects within companies.
... The "helping hands" hypothesis, however, implies CPCs positively influence firms' outcomes because of favours obtained from politicians (Shleifer and Vishny, 1998). These two-sided hypotheses have been widely used in the Chinese context (Cheung et al., 2010;Wang, 2015;Chen et al., 2017). In the US, studies have focused on testing whether CPCs can pose an agency problem or investment for companies. ...
... They attributed this to weaker governance and higher agency costs in Republicanleaning firms. Similarly, the "grabbing hands" hypothesis argues that CPCs can result in over-investment problems to satisfy the political agenda, consequently higher firm total risk (Wang, 2015). In Pakistan, Khan (2024) finds evidence on firm's wealth exploitation by politically affiliated individuals. ...
Employing panel data of US firms (1992-2018), we examine total risk for politically connected firms, formed through campaign contributions, and whether these connections impact the negative association between female presence in the TMT and total risk. The results show that corporate political connections are related to lower total, systematic, and idiosyncratic risk. Their interaction with TMT gender diversity further reduces total risk, by lowering idiosyncratic risk. This suggests that political connections have more profound benefits by influencing asset prices, as a non-market strategy reducing stock returns volatility. They also strengthen and complement the negative association between TMT gender diversity and total risk.
... Local governments control the approval of land, capital, essential means of production, and significant investment projects (Kong et al., 2018). Previous economic literature notes that firms with political connections enjoy lighter taxation and more valuable resources in terms of bank loans and government subsidies (Wang, 2015). As a result, local firms deliberately cater to the local governments' need to meet targets. ...
... As a result, private firms have a more substantial incentive to establish a political connection to gain access to scarce resources. Unlike private firms, government officials have a significant incentive to use SOEs to achieve their political goals, asking a local SOE to hire a surplus of labor to reduce the unemployment rate (Wang, 2015). However, the personnel and management rights of central SOEs are under the control of the central government, and local governments have low power over central SOEs. ...
This research paper delves into the intricate relationship between government policies, corporate behavior, and labor investment efficiency (LIE) within the unique context of China’s transitional economy. Drawing on a sample of domestically listed non-financial A-share listed companies in China from 2007 to 2019, we find that government employment target pressure decreases corporate LIE, which derives from overinvestment in labor. Mechanical tests show that this government-corporate cooperation under government employment target pressure is resultant of the incentives for firms to obtain subsequent government support and for governments to achieve future social stability. Further analysis suggests that employment target pressure can also lead firms to increase low-quality human resources and decrease high-quality human resources. The negative effect of government employment target pressure on LIE is only present in local state-owned enterprises (SOEs) and private firms, and more pronounced when the mayor of the city where the enterprise is located is nearing retirement and when firms are facing greater pressure from industry competition. Our study extends the traditional agency theory framework, highlighting the interplay between government influences and corporate decision-making in economies where the government holds substantial influence. We explore how government employment targets, initially aimed at societal goals, intertwine with corporate strategies, shaping labor investment decisions. This research offers new perspectives on the drivers of corporate behavior and the optimization of labor investment strategies in the presence of political pressures. For managers, our findings underscore the need for a strategic approach that balances short-term compliance with government targets and long-term LIE. Policymakers can benefit from insights into the potential unintended consequences of government employment target pressure, encouraging the design of more effective policy frameworks that align short-term employment targets with long-term economic growth and resource optimization. This study contributes to the growing literature on government-corporate relationships and provides valuable insights into the complex interplay between government policies and corporate decision-making in a transitional economy like China.
... A significant association exists between WGIs and Total asset turnover Gupta (2011), Sokolov and Solanko (2017) A significant association exists between WGIs and Dividend payout ratio Mitton (2004), Benavides et al. (2016) and Hofmann (2018) A significant association exists between WGIs and Operating Expenses/Total Assets Mueller andStewart (2011), De Schoenmaker et al. (2014) A significant association exists between WGIs and Long-term debt ratio (2005), Faccio (2006), Claessens et al. (2008), Cull et al. (2015), C. J. Chen et al. (2011Chen et al. ( , 2014, Boubakri et al. (2012Boubakri et al. ( , 2013, Yeh et al. (2013), Yang et al. (2014), Lashitew (2014), and Preuss and Königsgruber (2021) offer evidence on the easiness to borrow a loan from the bank when firms have good political connection, which, therefore, increases the value of firms and improves financial performance (Fisman, 2001;Johnson & Mitton, 2003;Ramalho, 2007;Roberts, 1990). Accordingly, Bliss and Gul (2012), Ebrahim et al. (2014), and L. Wang (2015) report that politically connected large firms are significantly associated with higher leverage. ...
... These characteristics provide easy access to bank loans that results in an increase in leverage. This result is extended by the findings reported by Agrawal and Knoeber (2001), Johnson and Mitton (2003), Ramalho (2007), Yeh et al. (2013), L. Wang (2015), and Preuss and Königsgruber (2021). ...
This paper examines the effects of institutional quality on firm-level financial performance. The data include non-financial firms listed in stock exchanges in G8 and MENA countries. The total number of firms in the G8 and MENA is 347 and 389, respectively, covering the period 2017–2020. The results show that, in the G8 countries, institutional quality is associated significantly and positively with asset efficiency, expense control, debt financing, and liquidity. In the MENA countries, institutional quality is associated significantly and positively with liquidity and profitability, but negatively with asset efficiency, expense control, and debt financing. The results show that the effect of corporate size is asymmetrical. The results also reveal a significant institutional convergence between G8 and MENA countries in terms of voice & accountability, political stability, and government effectiveness. Nevertheless, institutional quality in the G8 is better off that of the MENA countries in terms of Rule of law, Control of Corruption, and Regulatory Quality. The results also show that the duration of improvement in institutional quality takes between 2–4 years to have a significant effect of firms’ financial performance. This paper offers a contribution to corporate managers in terms of offering a guide to design financial strategies that adapts to the quality of institutions in the respective countries. A further contribution is offered to policy makers in terms of offering a road map to improve institutional quality that helps improve the financial performance of the business sector.
... Independent directors play an important advisory role in offering unbiased advice and perspectives to firms (Wang, Feng, & Xu, 2019). Their political connections can be valuable to the firms' resource acquisition and assist in strategic decision-making (Wang, 2015). Thus, we use the total number of political connections held by independent directors as another alternative measure of Breadth and the highest levels of their political connections (scaled by the number of independent directors) as a second alternative measure of Depth. ...
Political connections have been tested for correlation with outward foreign direct investment (OFDI). Both theoretical rationale and research evidence are mixed. To advance this debate, we conceptualize political connections as a dual-dimensional construct and hypothesize the differential effects of the breadth and the depth of political connections on OFDI. Employing a sample of 2,374 Chinese listed firms, encompassing 15,647 firm-year observations from 2008 to 2016, we find evidence supporting our hypotheses: (1) the breadth of political connections reduces the likelihood of a firm engaging in OFDI and (2) greater depth of political connections increases the likelihood of a firm engaging in the OFDI. Thus, we advise firms to exercise caution when adopting corporate political strategies for internationalization in general and OFDI in particular.
... We contend that while RPTs are ideally designed to improve transaction efficiency, they often deviate from this purpose and result in the expropriation of minority shareholders' wealth. This expropriation often stems from controlling shareholders exerting undue influence on major business decisions, facilitated by extensive shareholdings across affiliated firms within a group, often organized in a pyramidal ownership structure (Jiang et al., 2010;Wang, 2015). This approach impedes the transparency of information disclosure and facilitates tunneling activities, particularly in operations-related financial activities. ...
We examine the interplay between corporate social responsibility (CSR) and related party transactions (RPTs). As per our findings, aggregate RPTs is associated with higher CSR expenditure. The level of business RPTs positively correlates with CSR spending, whereas a negative association is witnessed in the case of tone RPTs. Further analysis reveals a greater propensity among firms with significant RPTs to expropriate resources through manipulative earnings management practices that could lower CSR spending. We also document that high ownership concentration reduces CSR expenditure. While the results are robust to alternate variable and model specifications, concerns surrounding endogeneity and sample selection bias have been addressed through the use of two-step system generalized method of moments (GMM) estimations and the Heckman two-step selection models, respectively. The study extends the extant literature on the relationship between CSR and RPTs, with the potential moderating roles of earnings management and ownership concentration. From regulatory standpoint, the focus should be on the implementation of robust monitoring mechanism to curb misuse of RPTs as a tool for expropriating firms’ resources. Indian firms, on their part, should strengthen their internal corporate governance mechanisms to improve transparency in RPTs oversight, ensuring alignment with sustainability goals.
... The fiscal decentralization in China have increased the complexity of relations between the government and enterprises, as well as between government officials and entrepreneurs (Chen et al., 2011). This complexity, compounded by the self-interest of both government and enterprises, has resulted in distortions and alienation within government-business relations (Lin et al., 2014;Wang, 2015). Constructing a positive government-business relationship poses a significant global challenge. ...
Introduction
Government-business relations are a concentrated manifestation of the interaction process and outcomes between the government and enterprises, directly influencing the social capital and institutional environment upon which businesses rely. Sound government-business relations are crucial for addressing environmental issues and promoting high-quality development in China.
Methods
This study extensively examines how New Government-business Relations (NGR) impact Corporate Environmental Performance (CEP) by analyzing A-share listed companies from 2017 to 2021 and applying the regulatory capture theory.
Results
The empirical findings show that NGR can prevent environmental regulatory capture, thereby improving CEP. After conducting several robustness tests, such as substituting the dependent variable, using instrumental variables, and performing dynamic panel analysis, the results remain consistent. Additionally, the mechanism analysis reveals that NGR can effectively thwart environmental regulatory capture resulting from rent-seeking behavior and political connections, leading to enhanced CEP. Moreover, additional research indicates that the beneficial impact of the NGR on the environmental performance of non-high-pollution industry enterprises, mature enterprises, and businesses operating in regions with stringent environmental regulations is more significant.
Discussion
Building on prior literature, this paper augments the body of relevant research on environmental regulatory capture within the Chinese context, offering fresh insights and empirical evidence to comprehend the evolving government-business relations in contemporary times and their significance in environmental conservation.
... In the current literature, there is a lack of research on the combination of corporate party perception and shareholder-oriented ESG. Most scholars only analyse from the perspective of political motivation and believe that by having political advantages, enterprises aim to enhance the tunnelling behaviour of controlling shareholders (Wang, 2015) and crowd out resources that can be used to improve ESG performance (Liang & Renneboog, 2017). This makes connected politicians tend to shield enterprises from environmental infringement investigations (Berkman et al., 2010) and boldly evade some necessary compliance measures (Fisman & Wang, 2015), thus reducing the cost of sanctions after enterprises pollute the environment (Wu et al., 2016). ...
Policies are important factors in regulating environmental sustainability. However, how to identify firms’ false environmental social behaviors and judge the impact of firms’ policy responsiveness on ESG is still lacking in the existing literature. We use the Chinese political acuity (CPA) dictionary and machine learning algorithms to measure political following and calculate governance deviation to the environment and society. Then, based on Chinese listed companies from 2013 to 2020, we empirically explored the relationship between political following and shareholder-oriented ESG.Political following can reduce the shareholder-oriented ESG tendency, and this relationship is robust. This effect is mainly achieved through information channels, influence channels and emotional channels. Moreover, the improvement of environmental protection by political following is superior to social responsibility. In addition, the relationship between political following and shareholder-oriented ESG is positively moderated by cost leadership strategy and negatively moderated by economic distress.This paper can make up for the neglect of the single index of traditional ESG rating in the existing literature, and promote the study of the relationship between government and enterprise to the field of political following.Policy implications: Our approach allows for a more realistic identification of ESG behaviour and provides strong evidence that political follow-through can enhance environmental sustainability. It has practical significance for the green transformation of enterprises and the accurate implementation of government policies.
... Based on prior research, other non-state MLS may gain from collusion through mechanisms, such as inter-company loans and guarantees (Berkman et al., 2009;Jiang et al., 2010), preferential pricing of their shares in IPOs, or subsequent rights issues (Chen, Jian, & Xu, 2009), etc. Additionally, as previously mentioned, the Chinese government is still highly influential in assigning key resources, including operating licenses and land (e.g., Wang, 2015). Therefore, the firm paying more taxes in return for the extra-private benefits may be more acceptable to other non-state MLS. ...
In recent years, the variation in firms' tax-avoidance behavior has attracted a lot of attention, both theoretically and empirically. This study investigates the governance role of multiple large shareholders in firms' tax-avoidance behavior, using a sample of Chinese state-controlled listed firms over the period 2004–2016. We find that the ownership stake of a firm's largest shareholder is negatively associated with tax avoidance among state-controlled firms. Second, other large non-state shareholders negatively affect tax avoidance of state-controlled firms. The former effect is particularly strong when the local government is the controlling shareholder. Finally, differences in institutional quality influence the largest shareholder's tendency to engage in tax avoidance in state-controlled firms. For state-controlled firms, a better institutional environment elicits more tax avoidance and thus curtails minority-investor expropriation.
... It is worth highlighting that these benefits, political connections, and CSR contributions are mutually reinforcing. Political connections give companies a better chance to obtain government-controlled resources, such as access to funding (loans, bonds, and equity), subsidies, government procurement contracts, and so forth (Feng, Johansson, and Zhang 2015;Ge et al. 2020;Tsai 2015;Wang 2015). 36 As a way to pay back, companies are often required to contribute to CSR. 37 Meanwhile, contributing to CSR is a good way to build political connections and reinforces pre-existing political connections (Lin et al. 2015, p. 329), 38 which may ultimately bring benefits. ...
Corporate social responsibility (CSR) in China is a result of political, regulatory, and administrative pressures and civil society pressures. The Chinese Communist Party (CCP) plays a dominant role in deciding the content of CSR, while the other influences are rather limited. As a result, Chinese CSR has not only voluntary and explicit elements but also mandatory and implicit elements. On the one hand, companies can perform CSR in a way that aligns with their commercial interests. On the other, CSR is a response to the CCP’s political pressure, while corporate failure to satisfy the requirements can result in serious negative impacts on companies’ business. In China, CSR has moved far from its origins as a tool of reputation enhancement and assumed a sui generis meaning as a tool of policy implementation. CSR has been evolving towards legal requirements in other jurisdictions as well, such as the EU. However, in China, the main force behind CSR comes from the CCP, which wields legislative and administrative power to promote CSR in a way that aligns with its political interests.
... The monopoly power of politicians is relevant and can act as a market failure to negatively affect lobby groups. There is the possibility that political connections between politicians and firms are used as a means to extract various forms of rents from firms (Cheung et al., 2010;Shleifer & Vishny, 1994;Wang, 2015). The "helping hand" of politics can then easily be replaced by a "taking hand," depending on the design of market power in the market for politics. ...
Politics in parliamentary democracies can be conceptualized as a market for political services. This chapter proposes a theoretical approach to identifying market failures in the political market, with a particular focus on the role of lobby groups. Monopoly power, asymmetric information, and externalities are identified as types of market failures that hinder the efficient functioning of the political market, particularly in the presence of lobbying. These market failures can lead to policy failures, where politicians represent the interests of lobby groups instead of the preferences of citizens. The paper also suggests possible solutions to reduce market failures in the political market through increased competition.
... Studies have shown that board members with political connections are more likely to pursue funding from government sources (Goldman, Rocholl, and So 2009;Hillman 2005). However, when it comes to independent directors, Wang (2015) found that their oversight abilities were not as effective as the resources obtained through government funding. Shi et al. (2018) further confirmed this by comparing politically connected and politically independent independent directors. ...
The success and value of a company depend heavily on effective governance practices. Efficient management of working capital is also crucial for maximizing profits and increasing the company’s worth. To better understand the connection between board composition and net working capital, we analysed the FTSE All-Share Index from 2012 to 2021. Our research discovered that the inclusion of independent directors and the rate of adjustment linked to an increase in independent board members had a negative impact on working capital management. However, we could not identify significant connection between gender diversity on the board and working capital investments. Therefore, our findings suggest that the presence of independent directors may indicate a proactive approach to working capital management with the aim of maximizing the company’s value.
... According to a report by China Securities Journal, from 2011 to 2013, among tens of thousands of votes on the board of directors of listed companies, IDs cast a total of 47 negative votes and 94 abstentions. 3 IDs do not perform their duties well not only because many are incapable (Cheng 2018;Fan 2021), but also because firms are inclined to hire government-affiliated IDs for connection establishment (Wang 2015). Consequently, IDs in China are inevitably marginalized, and their duties are alienated to provide limited consultation and more personal political connections. ...
Connections give diversified firms an advantage. This study investigates whether firms will be less diversified when the connections to the government are abruptly interrupted, using a dataset on the firm’s subsidiaries and the political connectedness of all listed private firms in China. In 2013, an unanticipated reform intended to combat corruption forced all politically connected independent directors of listed firms to resign. We find that those affected firms become less diversified after the reform. The estimation results are not driven by changes in the number of subsidiaries, government development goals, CEO’s political incentives, or other commercial system reforms. Placebo events for SOEs and firms’ academic background yield no effects. The effects are larger for local connections and stronger institutions. We also find that depoliticized firms are less likely to enter regulated and profitable industries and acquire less government economic support. Our results suggest that diversified firms could be ‘parasites’ of the economic-political institutions in emerging markets.
... For instance, the local governments may care more about social welfare rather than firm performance. They may ask a connected firm to meet output growth targets, even if the firm cannot sell all of its output at a profit (Wang, 2015). In addition, politicians could deliberately transfer resources of their connected firms to related parties to realize their own political goals (Huyghebaert and Wang, 2012). ...
... Continuance intention in information systems (IS) relates to variables contributing to long-term IS use (Franque et al., 2021a, b). Its significance stems from an awareness of the long-term elements contributing to the IS's performance (Bhattacherjee, 2001;Lin et al., 2017;Wang, 2015). While m-payment is considered an information system, continuance intention might help the success of m-payment service acceptance among Muslim IJBM users to embrace donations (Sadaqah) services. ...
Purpose
Despite the significance of donations (Sadaqah) via mobile payment in Islamic countries, little is known about the variables influencing continuance intention toward using m-payment for donations (Sadaqah). Based on the stimulus-organism-response (S-O-R) model, this research explores the influence of perceived quality (i.e. system, information, service) as a stimulus on customer satisfaction, engagement and delight as organisms, which then affects continuance intention toward using m-payment for donations (Sadaqah) as a response. Moreover, the study investigates the moderating role of Islamic religiosity.
Design/methodology/approach
Using partial least squares structural equation modeling (PLS-SEM), a representative data sample of 419 Egyptian Muslims was analyzed to test hypotheses.
Findings
The findings revealed that all perceived quality constructs significantly positively affect customers' satisfaction. Customer satisfaction, in turn, positively affects customer engagement and delight. Moreover, customer engagement, delight and Islamic religiosity significantly positively affect continuance intention toward using m-payment for donations (Sadaqah). The findings also revealed that Islamic religiosity moderates the influence of customer engagement and customer delight on continuance intention toward using m-payment for donations (Sadaqah).
Originality/value
This is the first study to examine using m-payment for donations (Sadaqah) in an Islamic environment based on the S-O-R model.
... However, some BGs-particularly those in Asia-staff their boards with independent directors who also have current or former government affiliations, showing a certain level of political capital (e.g., Chizema et al., 2015;Rhee and Lee, 2008;Wang, 2015). The directors' political ties are important not only for control (especially in state-owned BGs), but also for the service (i.e., resource provision) and strategic roles of boards. ...
In this monograph, we discuss the corporate governance of business groups (BGs). To this end, we broadly define both BGs and corporate governance to provide an inter-disciplinary conceptualization. We begin by reviewing the key governance theories that scholars have applied to BGs thus far. We then examine the different corporate governance dimensions (ownership, boards of directors, top-management teams, external control mechanisms, and sustainability-related issues) across the different types of BGs. As a result, we identify what we know about these organizations’ corporate governance mechanisms. We close with a detailed discussion of fruitful areas for future research on BG corporate governance based on the gaps we identify.
... In addition, Li et al. (2008), Menozzi et al. (2011), Wang (2015, and Wu et al. (2018) reveal that political connections play a vital role in the firm performance of SOEs. A substantial state ownership is better than a dispersed ownership structure because of the benefits of political connections and support from the state Yu, 2013). ...
This book highlights the latest research on responsible business and its pratical implications for the economy, society, academia, and politics. It presents selected contributions from respected scholars and experts who have conducted international research on corporate social responsibility, sustainability, ethics, corporate governance, finance, and responsible investing.
Purpose
This study aims to investigate the relationship between political connections and the narrative disclosure tone of management discussion and analysis (MD&A) reports in Indonesia during the normal economic (2018 to 2019) and the COVID-19 pandemic (2020 to 2021) periods.
Design/methodology/approach
Data on political connections were collected manually from annual reports, government websites and online search engines. Meanwhile, the narrative disclosure tone was measured from the MD&A reports according to the wordlist by Loughran and McDonalds (2011) processed with Diction 7 software. Multiple linear regression was used to test 414 nonfinancial corporations listed on the Indonesia Stock Exchange for the 2018–2021 period.
Findings
Under normal economic conditions, the results support impression management theory, where political connections are used to frame information with a more positive tone. Data obtained during the COVID-19 pandemic, on the other hand, confirm the incremental information theory. Furthermore, companies connected to actively serving state leaders consistently present MD&A reports with a more positive tone in both research periods. Proximity to legislative and government institutions allows politically connected companies (with members of the parliament or any political figures/party leaders/officials with strategic functions) to present MD&A reports with a negative tone and more information during the pandemic. The results are robust to alternative measures and endogeneity testing.
Originality/value
To the best of the authors’ knowledge, this is the first study to explore the association between political connections and narrative disclosure tone in Indonesia by considering the moderating role of the COVID-19 pandemic.
This study examines the relationship between hierarchical political power and the value of cash holdings. To model the power structure, we utilize the hierarchical civil service system in China to distinguish between the holders of high‐ and low‐level political power. We establish that directors with high‐level political power increase the market value of cash, whereas those with low‐level political power have no impact. Such effects are more pronounced in non‐state‐owned firms, in regions where politicians are subject to higher political pressure and in firms experiencing stronger agency conflicts. Further analysis shows that directors with high‐level political power can increase the value of cash holdings through improved investment efficiency. Among directors with high‐level political power, shareholders benefit most from the presence of those ranked at the Bureau‐Department level. Our study provides original evidence that political hierarchy holds significance for investors’ valuation of cash holdings and emphasizes the importance of the heterogeneous nature of boards’ political capital in determining corporate value.
Purpose
With the continuous deepening of China's mixed-ownership reform, the participants in the reform have gradually expanded from state-owned enterprises to private enterprises. Whether state-owned equity participation in private enterprises can facilitate the development of environmental, social and governance (ESG) performance in private enterprises is a question that needs urgent examination. This study aims to investigate the impact of state-owned equity participation on the ESG performance of private enterprises.
Design/methodology/approach
Using Chinese listed companies as the research sample, this study uses econometric methods such as multiple regression to analyze the relationship between state-owned equity and the ESG performance of private enterprises. Additionally, it explores the underlying mechanisms and influencing factors of this relationship.
Findings
There is a significant inverted U-shaped relationship between state-owned equity and the ESG performance of private enterprises. Mechanism analysis reveals that resource effects and governance effects play a mediating role in this nonlinear relationship. Furthermore, the authors find that environmental regulation and managers' attention to the environment positively moderate the relationship between state-owned equity participation and ESG performance.
Practical implications
A reasonable equity structure is crucial for enhancing corporate ESG performance. Moderate state-owned equity participation helps to leverage resource integration and governance advantages, which will assist private enterprises in maximizing ESG performance and achieving sustainable development.
Social implications
In advancing the process of mixed-ownership reform, the government should maintain an appropriate proportion of state-owned equity to avoid excessive intervention in enterprise decision-making. At the same time, it should ensure that enterprises can genuinely undertake their social and environmental responsibilities while pursuing economic benefits. This is of great significance for promoting sustainable economic and social development.
Originality/value
This study integrates state-owned equity, ESG and nonlinear relationships into a single research framework. It explores the internal mechanisms and influencing factors of their relationship, overcoming the limitations of previous studies and provides a new perspective for understanding the impact of state-owned equity on corporate ESG performance.
Research Question/Issue
This study investigates the effect of connections to the Politburo, the top 25 members of the Chinese Communist Party (CCP), on CEO compensation, pay‐for‐performance sensitivity, and turnover decisions using a comprehensive dataset of 3764 Chinese listed firms from 2007 to 2019.
Research Findings/Insights
Our findings reveal that CEOs of privately owned listed firms who have connections to the Politburo via shared educational backgrounds receive significantly higher compensation (up to 20% more). However, such connections do not significantly affect CEO compensation in state‐owned enterprises (SOEs). CEOs who have connections to the Politburo also exhibit lower turnover rates, and their compensation is less sensitive to performance outcomes. Our measure of connections excludes reverse causality, as we leverage an exogenous shock—the promotion to the Politburo of an individual with whom the CEO is already connected—to investigate the gain associated with a political connection in the absence of CEO turnover in private firms. This event allows us to observe that CEO pay increases significantly in such cases. We also find that elite connections serve as a mechanism for resource allocation, as politically connected CEOs in private firms benefit from higher subsidies and lower tax rates, and politically connected CEOs in SOEs benefit by being appointed to larger SOEs. Additionally, we find that the positive relationship between CEO pay and elite connections is even stronger when the connection is stronger but is negative when the CEO is a CCP member.
Theoretical/Academic Implications
This study enriches the literature on political connections by introducing a novel proxy for elite connections based on past educational ties to members of the political elite. It disentangles the influence of personal educational connections to the political elite from that of a more generic political membership of the CCP, offering a clearer understanding of their distinct impacts.
Practitioner/Policy Implications
Our study underscores the necessity of differentiating between private and SOEs in China due to their distinct characteristics and goals. Furthermore, it highlights the critical role of elite political connections in emerging economies such as China in resource allocation, labor market dynamics, and corporate governance.
Exploiting China's anti‐corruption campaign in 2012 as a quasi‐natural experiment, we find that firms with higher prior entertainment and travel costs (ETC), a proxy for corruption, decrease cash holdings more because of the campaign. We further observe a greater decline in cash values for more corrupt firms. Moreover, the baseline pattern is more pronounced in financially constrained, better‐governed, and private enterprises. We also rule out possible confounders concerning firms' financing conditions and investment decisions. Overall, the evidence favours the liquidity hypothesis that firms demand less cash as they anticipate fewer corrupt opportunities in the business environment in the post‐campaign era.
Purpose
This paper examines the relationship between heterogeneous political connections and corporate overinvestment.
Design/methodology/approach
Based on a comprehensive Malaysian dataset of 834 publicly listed companies from 2000 to 2022, the authors employed multivariate ordinary least squares regression to test the relationship.
Findings
Despite different types of political connections, the findings demonstrate a positive relationship between political connections and corporate overinvestment. In particular, the association is more profound in government-linked companies (GLCs) but weaker in firms that developed political ties through family members of ruling elites. Further analysis reveals that the “helping hand” effect is only observed in GLCs and firms with politically connected directors and businessmen, whereas the “grabbing hand” effect is observed among firms connected through board, businessmen, and family ties. Moreover, the relationship is more persistent among firms with politically connected directors and businessmen around the regime change.
Research limitations/implications
Regardless of the types of political connections, the findings show that politically connected firms tend to engage in rent-seeking through political patronage networks and high levels of government interference in resource allocation. Therefore, a more sophisticated monitoring system should be developed within the political patronage networks to reduce the likelihood of different types of political-business collusion. In terms of research limitations, the research design does not consider the influence of financial constraints and management efficiency. Future research could explore these facets to comprehensively understand the dynamics between political connections and corporate investment decisions.
Practical implications
The evidence informs market participants about the relationship between heterogeneous political connections and corporate overinvestment, reinforcing previous findings that crony capitalism, political patronage, agency problems, and weak governance are well-entrenched in Malaysia’s emerging economy. The government should acknowledge these concerns by enacting anti-corruption campaigns and promoting a fair business environment. In the meantime, policymakers might redesign regulations and revise corporate governance frameworks to substantially reduce the value of political connections, thereby diminishing the bargaining power of politicians.
Social implications
As corporate investment efficiency has a considerable impact on firm value, investment decisions that enhance firm value will increase share price and maximise shareholder value. Conversely, firms may damage shareholder value if they overinvest or undertake projects that do not yield sufficient. Hence, the findings of this study may assist investors in making more informed judgements, particularly by understanding different types of business-government relations, as political connections are one of the determinants of corporate overinvestment.
Originality/value
This study reveals that the degree to which overinvestment issues manifest within firms is influenced by the nature of the political connections those firms possess. This indicates that politically connected firms should not be regarded as a homogenous group of firms.
Using a sample of Korean-listed firms, this study investigates whether there is an association between political connections and market reaction. Specifically, we examine the association between the appointment of politically connected outside directors (PCODs) and cumulated abnormal returns and whether politically connected directors affect stock price crash risk. We find that firms appointing PCODs experience a negative market reaction on the announcement date of hiring them. However, firms with PCODs on the board are less likely to experience stock price crash risks. These results can be interpreted as follows: when firms appoint politically connected directors, investors initially criticise this event as political ties may corrupt fair trade. However, it may also be argued that firms with political connections have incentives to improve accounting transparency due to negative public concerns for a possible back-scratching alliance between the government and businesses and attract greater public attention from the media and investors. In other words, although PCODs may impose a negative perception on investors, these directors may contribute to their firm by playing a significant role in advising and/or protecting the firm using their previous work experience and connections.
Purpose
Research on the political connections of multinational enterprises’ (MNEs’) subsidiaries in emerging host countries has been growing. The purpose of this paper is to integrate institutional and resource dependence theories to argue that MNEs-subsidiaries are likely to develop fewer formal (i.e. board-level) political connections when operating in welfare-state monarchies as compared to in host countries with developmental-state democratic systems. Furthermore, this paper argues that MNE-subsidiaries develop formal political connections to a greater extent in industries where religion influences the development of products and services considerably. Finally, the extent of developing formal political connections varies by the scale of the MNEs’ investment (or subsidiary density) in the host market.
Design/methodology/approach
The paper tests its hypotheses on a sample of foreign-owned subsidiaries operating in Saudi Arabia and Egypt. The data was collected by combining information from Bureau Van Dijk’s Orbis database with company websites and other secondary sources. The final sample consisted of 156 observations – 70 MNEs-subsidiaries operating in Saudi Arabia, and 86 in Egypt.
Findings
The findings confirm that foreign subsidiaries are likely to develop fewer formal political connections in a welfare-state monarchy as compared to in a developmental-state democratic system. Furthermore, formal political connections are more significant in industries that are impacted by the influence of religion – such as the financial industry in Arab countries. Finally, the extent of using political connections varies by the scale of the MNEs’ investment in the host market – that is, with a greater scale of investment (or higher subsidiary density), formal political connections are greater.
Originality/value
The paper contributes theoretically by explaining that a combination of institutional heterogeneity and its associated resource dependence conditions between MNEs and host governments influence MNE-subsidiaries' political connections. The paper tests its hypotheses in an emerging Arab context, which is characterized by both autocratic and semi-democratic political settings, and which makes the integration of institutional and resource dependence theories useful in explaining how MNE-subsidiaries navigate local complexities in this region.
Using unique hand-collected data of related party transactions (RPTs) between state-owned enterprises (SOEs) and government noncorporate agencies in China, we investigate the behavior of government resource allocation and its impacts. We find that Chinese governments are more likely to allocate resources to SOEs with a politically connected chairperson of the board through RPTs. The results remain robust after considering endogeneity concerns. In SOEs with a politically connected chairperson, resources obtained through RPTs are not associated with improved economic outputs except for increased investment expenditures. In addition, resources obtained are associated with improved labor cost stickiness. Our results add new evidence of the political exchange between Chinese governments and SOEs facilitated by politically connected executives.
JEL Classification: G30, G38
This article empirically examines how political connections ( PCs ) affect a firm's media reaction after corporate fraud. Using data for Chinese listed companies from 2008 to 2021, we find that the media reports more positively for firms with PC s than for others that do not possess such advantages after the enforcement against fraud. The results are robust to a series of robustness checks and endogeneity corrections. When decomposing media reports, we find that PC s only facilitate positive media coverage but do not impede negative media coverage, which is more pronounced in state‐controlled media. This suggests that PC s protect firms’ branding by facilitating positive media reports rather than withholding bad news. Moreover, we find this protective effect is more pronounced in firms with stronger PC s, weaker anti‐corruption regulation, lighter punishment for fraud, private ownership, and more donations. Further, the consequences analysis shows that this kind of protective effect significantly increases the probability of future fraud and stock price crashes. Our findings present a new perspective on the role of PC s and provide evidence for political bias in media coverage.
We examine the effects of environmental resources policy on enterprises total factor productivity (TFP), based on data of manufacturing companies from 2008 to 2017 and a three-subject framework of central government, local governments, and enterprises. A difference-in-differences assessment strategy is constructed using China's new environmental protection law as a quasi-natural experiment for the regulatory environment. The results show that the new Environmental Protection Law can promote enterprises TFP. And after performing multiple robustness tests, the results remain significant. We then explore the heterogeneous effects of enterprise political resources and find that there is a “political resource curse” effect in Porter hypothesis, i.e. stringent environmental regulations cannot promote the TFP of enterprises with political resources. Local government political connections may have led to a “political resource curse” effect, rather than central government. This article accordingly proposes targeted policy recommendations to improve the total factor productivity of enterprises and promote national economic development.
This study examines the effect of corporate site visits on resource extraction. Taking advantage of China's mandatory disclosure of detailed investors' site visits information, we find that firms with more investors' site visits have lower levels of managerial private consumption and tunnelling. This association is more pronounced when the monitoring effect of corporate site visits is more efficient, and the agency problem is more severe. We utilise the two‐stage least squares (2SLS) estimation approach to demonstrate the robustness of our results. Collectively, our findings highlight the external monitoring role of investors' site visits in reducing corporate agency conflicts.
This study reviews contemporary corporate governance (CG) in China. This is crucial because of the lack of awareness in the foreign investor community concerning the transparency and reliability of the second-largest economy’s governance policy. The review offered in this study not only contributes to the expanding literature in relation to the Chinese CG model, but also further deepens the understanding of the governance issues concerning businesses operating in China among foreign institutional investors and foreign corporate practitioners. The significance of promoting the transparency and integrity of Chinese firms and capital markets is ensuring that firm assets are used diligently and effectively to safeguard the interests of investors and other relevant stakeholders. Moreover, this study sheds light on the latest developments in the Chinese capital market, regulatory framework, and CG perspective for managers of multinational firms to evaluate their potential direct investment decisions in China. In addition, this study provides a review of existing literature on whether Chinese CG is converging towards or diverging from the Anglo-American model, which may be helpful for the decision-making process of Chinese policymakers and regulators in relation to the formulation of new codes, regulations, and policies in the future.KeywordsChinese corporate governanceChinese Code of Corporate Governance for Listed CompaniesAnglo-American corporate governanceAnglo-Saxon corporate governanceGerman corporate governanceChinese capital marketChina Securities Regulatory CommissionBoard independenceState ownershipConcentrated ownershipSupervisory boardInstitutional investorsState-owned enterprisesNarrative reviewConvergenceDivergenceAgency theorySOECSRCQualified Foreign Institutional InvestorsShanghai Stock ExchangeShenzhen Stock ExchangeShare split reformOrganisation for Economic Co-operation and DevelopmentOECDChinese dual board systemDirector-manager agency issueDirectors-shareholder agency issueIndependent directorSarbanes Oxley Act 2002
This paper investigates the different effects of political connections on the firm performance of state-owned enterprises (SOEs) and privately owned enterprises. Using data on Chinese listed firms from 1999 to 2007, we find that private firms with politically connected managers outperform those without such managers, whereas local SOEs with connected managers underperform those without such managers. Moreover, we find that private firms with politically connected managers enjoy tax benefits, whereas local SOEs with politically connected managers are prone to more severe over-investment problems. Our study reconciles the mixed findings of previous studies on the effect of political connections on firm performance.
Drawing upon the resource-based view, this study examines how political connections affect corporate diversification in an
emerging economy. Data from a sample of 1,280 Chinese public firms over 2002–2005 show a strong positive relationship between
political connections and corporate diversification. We also find that the positive relationship between political connections
and corporate diversification is moderated by the level of state ownership in firms and the level of regional institutional
development. Theoretical and managerial implications are discussed.
We examine the wealth effects of three regulatory changes designed to improve minorityshareholder protection in the Chinese stock markets. Using the value of a firm’s related-party transactions as an inverse proxy for the quality of corporate governance, we find that firms with weaker governance experienced significantly larger abnormal returns around announcements of the new regulations than did firms with stronger governance. This evidence indicates that securities-market regulation can be effective in protecting minority shareholders from expropriation in a country with weak judicial enforcement. We also find that firms with strong ties to the government did not benefit from the new regulations, suggesting that minority shareholders did not expect regulators to enforce the new rules on firms where block holders have strong political connections.
We identify and analyze a sample of publicly traded Chinese firms that issued loan guarantees to their related parties (usually the controlling block holders), thereby expropriating wealth from minority shareholders. Our results show that the issuance of related guarantees is less likely at smaller firms, at more profitable firms and at firms with higher growth prospects. We also find that the identity and ownership of block holders affect the likelihood of expropriation. In addition, we use this sample to provide new evidence on the relation between tunneling and proxies for firm value and financial performance. We find that Tobin's Q, ROA and dividend yield are significantly lower, and that leverage is significantly higher, at firms that issued related guarantees.
This paper examines the role of affiliation with the ruling Communist Party in the operation of private enterprises in China. Using a nationwide survey of private firms, we find that the Party membership of private entrepreneurs has a positive effect on the performance of their firms when human capital and other relevant variables are controlled. We further find that Party membership helps private entrepreneurs to obtain loans from banks or other state institutions, and affords them more confidence in the legal system. Finally, we find Party membership to be more important to firm performance in regions with weaker market institutions and weaker legal protection.
Using novel indicators of political connections constructed from campaign contribution data, we show that Brazilian firms that provided contributions to (elected) federal deputies experienced higher stock returns than firms that did not around the 1998 and 2002 elections. This suggests that contributions help shape policy on a firm-specific basis. Using a firm fixed effects framework to mitigate the risk that unobserved firm characteristics distort the results, we find that contributing firms substantially increased their bank financing relative to a control group after each election, indicating that access to bank finance is an important channel through which political connections operate. We estimate the economic costs of this rent seeking over the two election cycles to be at least 0.2% of gross domestic product per annum.
Almost 27% of the CEOs in a sample of 790 newly partially privatized firms in China are former or current government bureaucrats. Firms with politically connected CEOs underperform those without politically connected CEOs by almost 18% based on three-year post-IPO stock returns and have poorer three-year post-IPO earnings growth, sales growth, and change in returns on sales. The negative effect of the CEO's political ties also show up in the first-day stock return. Finally, firms led by politically connected CEOs are more likely to appoint other bureaucrats to the board of directors rather than directors with relevant professional backgrounds.
This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Benjamin E. Hermalin and Michael S. Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards because makeup and actions are jointly endogenous. A focus of this survey is how the literature, theoretical as well as empirical, deals-or on occasions fails to deal-with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance.
Abstract Poor protection of private property has limited the access to bank loans by private enterprises in developing and transition economies. Under those circumstances, private entrepreneurs have resorted to various ways of enhancing the de facto protection of private property. Using a dataset of 3,073 private enterprises in China, this paper empirically investigates the impact of political participation and philanthropic activities – informal substitutes for the lack of formal protection of private property – on the access to bank loans.
This paper studies ownership dynamics in 221 Chinese state-owned enterprises that were partially privatized via the Shanghai Stock Exchange. We build probit models to investigate the further decline in government ownership after listing. We differentiate between share issuance, where state ownership is diluted as a result of rights issues and seasoned equity offerings, and government divestment. We find evidence that share issuance results in the dilution of state ownership in the highly profitable and leveraged firms that rely more on subsidies, while assets growth has a negative effect. The issuance decision is timed to occur when stock market conditions are favorable. Chinese authorities tend to sell part of their shares in the smaller and unprofitable firms reporting higher sales growth. Variables capturing the size of managerial incentive problems do not play an incremental role after controlling for firm performance. Finally, the divestment decision is not affected by windows of opportunity.
Manuscript Type: Empirical
Research Question/Issue: We investigate how ownership structure, board characteristics, and regional differences in law enforcement and stock market development affect the conflict of interest between majority and minority investors in Chinese listed firms. For this purpose, we study related-party transactions as well as labor redundancy, and classify firms as either state- or private-controlled.
Research Findings/Insights: We find that related-party transactions grow more extensive as the wedge between the controlling shareholder's control rights and cash flow rights increases. Related-party transactions also rise with voting rights held by the government in state-controlled firms. Next, the state as controlling shareholder exacerbates labor redundancy. The control rights of the second to tenth largest investors can offset expropriation. Regarding board characteristics, we find that a larger fraction of directors affiliated with the dominant owner enlarges related-party transactions, while large boards also increase labor redundancy in state-controlled firms. We find only weak evidence that higher-quality institutions help to restrain expropriation of minority investors.
Theoretical/Academic Implications: In Chinese listed firms, a major conflict of interest arises between majority and minority investors. Also, the state may exercise its control rights to achieve imperative social and political objectives, to the detriment of external investors. Yet, as the stock market valuation and financial performance of state-controlled firms rise with the fraction of shares held by the state, future research should better delineate the conditions under which state ownership is either detrimental or beneficial to firms. Next, the results indicate that governance mechanisms suggested by conventional agency theory are deficient in Chinese listed firms. Future research could therefore establish more clearly when internal and external governance mechanisms are likely to work, thereby also taking into account the identity of the controlling shareholder.
Practitioner/Policy Implications: Investors should be aware that expropriation in Chinese listed firms has specific implications when the state is the controlling owner. Also, at this stage of development, independent directors and external governance mechanisms can hardly protect the best interests of minority investors. Rather, expropriation is counterbalanced when voting rights are concentrated in the hands of other large block holders. Policy makers should work on ownership restructuring, board independence, and institutional quality to better protect minority rights in Chinese listed firms.
We examine a sample of related party transactions between Chinese publicly listed firms and their controlling shareholders during 2001-2002. Minority shareholders in these firms seem to be subject to expropriation through tunneling but also gain from propping up. On balance, there is more tunneling than propping. Both types of firms have larger state ownership compared to the rest of the Chinese market but firms that are propped up are larger and have larger state ownership than firms subject to tunneling. Propped up firms are more likely to have foreign shareholders and to be cross-listed abroad compared to firms that are subject to tunneling. Propped up firms also tend to have worse operating performance in the fiscal year preceding the announcement of the related party transaction. Finally, we find that related party transactions representing tunneling are accompanied by significantly less information disclosure compared to related party transactions representing propping.
abstract By examining the level of ownership concentration across firms, we determine how principal–principal conflict, defined as the incongruence of ownership goals among shareholder groups in a corporation, impacts agency costs of Chinese boards of directors. Based on data from Chinese companies listed on the Shanghai and Shenzhen stock exchanges during 1999–2003, we found that ownership concentration had a U-shaped relationship with board compensation, board size and the presence of independent directors. These results provide corroborating evidence that principal–principal conflict can lead to high agency costs.
The past reforms of state-owned enterprises in China delegated many effective control rights to managers while maintaining ultimate control rights for the Party and government. The result is that either the agency costs are high because managers lack accountability or the political costs are high because the government causes political interference. Reform of state-owned enterprises in China should aim at reducing both political and agency costs, which can be done through depoliticization, effective corporate governance, and deserialization. In particular, China needs an ownership transformation with a combination of privatization, denationalization, and pluralization; a state assets management system to limit political influence from the government; and corporatization to establish effective corporate governance which may take a variety of forms.
Using a large panel dataset of Chinese industrial firms, we find that poorly performing SOEs were more likely to redistribute credit to firms with less privileged access to loans via trade credit. While that could be consistent with the efficient redistribution of credit, it is more likely that these SOEs extended trade credit to prop up faltering customers that were in arrears. By contrast, profitable private domestic firms were more likely to extend trade credit than unprofitable ones. Trade credit likely provided a substitute for loans for these firms' customers that were shut out of formal credit markets. As biases in lending become less severe, the allocation of lending became more efficient, and the amount of trade credit extended by private firms declined. Our evidence implies that redistribution of bank loans via trade was not a major contributor to China's explosive growth.
Analysis of a worldwide sample of sudden deaths of politicians reveals a market-adjusted 1.7% decline in the value of companies headquartered in the politician's hometown. The decline in value is followed by a drop in the rate of growth in sales and access to credit. Our results are particularly pronounced for family firms, firms with high growth prospects, firms in industries over which the politician has jurisdiction, and firms headquartered in highly corrupt countries. © 2009 Michael G. Foster School of Business, University of Washington.
This paper examines the extent of firm level over-investment of free cash flow. Using an accounting-based framework to measure over-investment and free cash flow, I find evidence that, consistent with agency cost explanations, over-investment is concentrated in firms with the highest levels of free cash flow. Further tests examine whether firms’ governance structures are associated with over-investment of free cash flow. The evidence suggests that certain governance structures, such as the presence of activist shareholders, appear to mitigate over-investment.
This study examines the role of political connections in firms’ financing strategies and their long-run performance. We view political connections as an example for domestic arrangements which can reduce the benefits of global financing. Using data from Indonesia, we find that firms with strong political connections are less likely to have publicly traded foreign securities. As a result, estimates of the performance consequences of foreign financing are severely biased if value-creating domestic arrangements such as political relationships are ignored. Connections not only alter firms’ financing strategies, they also influence long-run performance. Tracking returns across several regimes, we show that firms have difficulty re-establishing connections with a new government when their patron falls from power, leading closely connected firms to underperform under the new regime and subsequently to increase their foreign financing.
This study examines the link between effective tax rates (ETR) and political connections in developing economies. The political connections explanation is informed by the observation that developing economies tend to be “relationship-based” rather than “market-based” capitalisms. Two proxies of political patronage are developed and applied to a group of Malaysian firms over a 10-year period. We find firms with political connections pay tax at significantly lower effective rates than other firms. Our results suggest that political connections are an important determinant of ETR in relationship-based economies.
Johnson et al. (2002. American Economic Review 92 (5), 1335–1356) examine the relative importance of property rights and external finance in several Eastern European countries. They find property rights to be overwhelmingly important, while external finance explains little of firm reinvestment. McMillan and Woodruff (2002. Journal of Economic Perspectives 16 (3), 153–170) further conjecture that as transition moves along, market-supporting (financial) institutions should become more important. This paper reexamines those issues in the context of China in 2002, when the transition had moved far. We also find that secure property rights are a significant predictor of firm reinvestment. However, in line with McMillan and Woodruff, we find that access to external finance in the form of bank loans is also associated with more reinvestment. Following Acemoglu and Johnson (2003. Unbundling institutions. Unpublished working paper 9934, National Bureau of Economic Research, Cambridge, MA), we separate our proxies for the security of property rights into two groups: those measuring the risk of expropriation by the government and those measuring the ease and reliability of contract enforcement. Whereas those authors’ cross-country results suggest that risk of expropriation is the more severe impediment to economic development, ours indicate that both expropriation risk and contract enforcement play a role in Chinese firms’ reinvestment decisions. We also find that another aspect of property rights, the extent of private ownership, is associated with greater reinvestment. At China's current stage of development, expropriation risk, contract enforcement, access to finance, and ownership structure all appear to matter for reinvestment decisions. Some evidence also exists that access to finance and government expropriation affect small firms more than large ones.
We examine how political connections impact the process of going public. Specifically, we test how political connections impact the pricing of the newly offered shares, the magnitude of underpricing, and the fixed cost of going public. Based on the experience of the newly public firms from Chinese security markets and using multiple measures of political connections, we find robust evidence that the issuing firms with political connections reap significant preferential benefits in the process of going public. To be specific, we find that firms – irrespective of their ownership status – with greater political connections have relatively higher offering price, lower underpricing, and lower fixed costs during the going-public process.
We investigate the extent of political connections in newly privatized firms. Using a sample of 245 privatized firms headquartered in 27 developing and 14 developed countries over the period 1980 to 2002, we find that 87 firms have a politician or an ex-politician on their board of directors. Politically-connected firms are generally incorporated in major cities, are highly leveraged, and operate in regulated sectors. The likelihood of observing political connections in these firms is positively related to government residual ownership, and negatively related to foreign ownership. Political fractionalization and tenure, as well as judicial independence are also key explanatory variables. Finally, politically-connected firms exhibit a poor accounting performance compared to their non-connected counterparts.
In this paper, we provide empirical evidence on the incentive role of personnel control in post-reform China. Employing the turnover data of top provincial leaders in China between 1979 and 1995, we find that the likelihood of promotion of provincial leaders increases with their economic performance, while the likelihood of termination decreases with their economic performance. This finding is robust to various sensitivity tests. We also find that the turnover of provincial leaders is more sensitive to their average performance over their tenure than to their annual performance. We interpret these empirical findings as evidence that China uses personnel control to induce desirable economic outcomes. Our study adds some basic evidence to a growing theoretical literature emphasizing the role of political incentives of government officials in promoting local economic growth.
We examine how the rent-seeking incentives of local government motivate private firms1 listed in China to establish political connections, and whether such connections lead to more concentrated corporate control structures. Our results show that such firms are more likely to establish political connections in regions in which the local economy is less market-oriented or in which the government has more discretion in allocating economic resources. This is consistent with the notion that the presence of incentives for government officials to engage in rent seeking motivates private firms to look for alternative safeguards through political connections. We also find that the controlling owners of politically connected firms tend to concentrate their shareholdings and dominate the board of directors by occupying the position of either chairman or CEO, which supports the conjecture that a concentrated control structure facilitates rent seeking through political connections and allows the controlling owner to retain all of the benefits arising from connections with politicians.
This article explores whether political connections are important in the United States. The article uses an original hand-collected
data set on the political connections of board members of S&P 500 companies to sort companies into those connected to the
Republican Party and those connected to the Democratic Party. The analysis shows a positive abnormal stock return following
the announcement of the nomination of a politically connected individual to the board. This article also analyzes the stock-price
response to the Republican win of the 2000 presidential election and finds that companies connected to the Republican Party
increase in value, and companies connected to the Democratic Party decrease in value.
If outside directors with backgrounds in politics and in law play a political role, they will be more important on the boards of firms for which politics matters more. We conduct three tests. First, for a sample of manufacturing firms, we find that politically experienced directors are more prevalent in firms where sales to government, exports, and lobbying are greater; lawyer-directors are more prevalent in firms where costs of environmental regulation are higher; and both are more prevalent in larger firms. Second, for a sample of electric utilities during the 1990s, when the advent of retail competition made politics more important, we find increased incidence of politically experienced directors. Finally, we explore whether a governmental taste for diversity creates a political role for women directors. Although we document increased incidence of women directors over time, we find little evidence that women directors play a political role. Copyright 2001 by the University of Chicago.
Corruption by the politically connected is often blamed for economic ills, particularly in less developed economies. Using a loan-level data set of more than 90,000 firms that represents the universe of corporate lending in Pakistan between 1996 and 2002, we investigate rents to politically connected firms in banking. Classifying a firm as "political" if its director participates in an election, we examine the extent, nature, and economic costs of political rent provision. We find that political firms borrow 45 percent more and have 50 percent higher default rates. Such preferential treatment occurs exclusively in government banks-private banks provide no political favors. Using firm fixed effects and exploiting variation for the same firm across lenders or over time allows for cleaner identification of the political preference result. We also find that political rents increase with the strength of the firm's politician and whether he or his party is in power, and fall with the degree of electoral participation in his constituency. We provide direct evidence against alternative explanations such as socially motivated lending by government banks to politicians. The economy-wide costs of the rents identified are estimated to be 0.3 to 1.9 percent of GDP every year. Copyright (c) 2005 Massachusetts Institute of Technology.
We present a model of bargaining between politicians and managers that explains many stylized facts about the behavior of
state firms, their commercialization, and privatization. Subsidies to public enterprises and bribes from managers to politicians
emerge naturally in the model. We use the model and several extensions to understand why commercialization and privatization
might work, and what forces contribute to effective restructuring of public enterprises. We illustrate the model using examples
from several countries.
This paper presents two propositions about corruption. First, the structure of government institutions and of the political
process are very important determinants of the level of corruption. In particular, weak governments that do not control their
agencies experience very high corruption levels. Second, the illegality of corruption and the need for secrecy make it much
more distortionary and costly than its sister activity, taxation. These results may explain why, in some less developed countries,
corruption is so high and so costly to development.
By tracing the identity of large shareholders, we group China's listed companies into those controlled by state asset management bureaus (SAMBs), state owned enterprises (SOEs) affiliated to the central government (SOECGs), SOEs affiliated to the local government (SOELGs), and Private investors. We argue that these distinct types of owners have different objectives and motivations and this will affect how they exercise their control rights over the firms they invest in. In particular, we contend that private ownership of listed firms in China is not necessarily superior to certain types of state ownership. To test our arguments we investigate the relative efficiency of state versus private ownership of listed firms and the efficiency of various forms of state ownership. The empirical results indicate that the operating efficiency of Chinese listed companies varies across the type of controlling shareholder. SOECG controlled firms perform best and SAMB and Private controlled firms perform worst. SOELG controlled firms are in the middle. The results are consistent with our predictions.
This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Hermalin and Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards due to the joint endogeneity of makeup and actions. A focus of this survey is on how the literature, theoretical as well as empirically, deals - or on occasions fails to deal - with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance.
We examine a sample of connected transactions between Hong Kong listed companies and their controlling shareholders. We address three questions: What types of connected transactions lead to expropriation of minority shareholders? Which firms are more likely to expropriate? Does the market anticipate the expropriation by firms? On average, firms announcing connected transactions earn significant negative excess returns, significantly lower than firms announcing similar arm's length transactions. We find limited evidence that firms undertaking connected transactions trade at discounted valuations prior to the expropriation, suggesting that investors cannot predict expropriation and revalue firms only when expropriation does occur.
This article surveys research on corporate governance, with special attention to the importance of legal protection of investors and of ownership concentration in corporate governance systems around the world. Copyright 1997 by American Finance Association.
Examination of firms in 47 countries shows a widespread overlap of controlling shareholders and top officers who are connected with national parliaments or governments, particularly in countries with higher levels of corruption, with barriers to foreign investment, and with more transparent systems. Connections are diminished when regulations set more limits on official behavior. Additionally, I show that the announcement of a new political connection results in a significant increase in value.
As the Indonesian economy went into a downward spiral in the latter half of 1997, there was much speculation and debate as to the reasons behind the sudden decline. Most explanations gave at least some role to investor panic, which had led to a massive outflow of foreign capital. At the root of this hysteria, however, were concerns that the capital that had flowed into Indonesia and elsewhere in Southeast Asia had not been used for productive investments. Much of this discussion focused on the role of political connections in driving investment. The claim was that in Southeast Asia, political connectedness, rather than fundamentals such as productivity, was the primary determinant of profitability and that this had led to distorted investment decisions. Obviously, the degree to which this type of problem was truly responsible for the Asian collapse depends very much on the extent to which connectedness really was a primary determinant of firm value. In making the argument that this was in fact the case, anecdotes about the business dealings of President Suharto’s children were often cited as evidence. Such stories suggest that the value of some firms may have been highly dependent on their political connections. However, investigations in this area have not progressed beyond the level of case study and anecdote. That is, there has been no attempt to estimate the degree to which firms rely on connections for their profitability. There are numerous difficulties that would