Although politicians have great influence on company profits, there is no such research in China which examines the impact of political connections on firms. This paper tries to complete this task in a special way. With the information publicized during China’s anti-corruption campaign, this paper tries to evaluate the reaction of connected firms to the abrupt arrests of ‘their’ politicians. It is assumed that the impact of political connections on firms can be estimated by the ex-ante and ex-post comparison....[ Read more ]

Although politicians have great influence on company profits, there is no such research in China which examines the impact of political connections on firms. This paper tries to complete this task in a special way. With the information publicized during China’s anti-corruption campaign, this paper tries to evaluate the reaction of connected firms to the abrupt arrests of ‘their’ politicians. It is assumed that the impact of political connections on firms can be estimated by the ex-ante and ex-post comparison.

This paper has found that connected firms experienced a significant negative CAR (-12%) over a 30-day event window and their profitability suffered one percentage point extra deterioration than non-connected firms in the three years after the arrests, which demonstrates political connections really contribute to the value of firms.

Further examination of financial variables shows clearly where the value of connections comes from. Connected firms have enjoyed easy access to debt financing (4.40 percentage points higher LT leverage ratio), tax relief (1.96 percentage points lower tax rate), and interest deduction (0.89 percentage points lower interest rate). They also hold larger market power (0.01 percentage point larger market share).

This paper also finds that over the 2-year window around the arrests, 63.64% (66.67%) of connected firms have replaced their chairman (CEO), which is significantly higher than the 31.90% (47.41%) turnover ratio of non-connected firms. As far as the ratio of post-event boards represented by continuing directors is concerned, the average (median) number of connected firms is 54.19% (54.55%), which is significantly less than the 64.81% (66.67%) ratio of non-connected firms. This dynamic corresponding relationship between politician turnover and firm manager turnover clearly depicts the significant impact of politics on China’s corporate governance systems.