Political connection, market frictions and financial constraints: evidence from China

Abstract

This paper studies the relationship between market frictions and political connections in determining financial constraints. We develop a novel index to measure the depth of political connections (PC) at the firm level and provide robust empirical evidence that firms in China actively build PC to alleviate the costs of market frictions. Specifically, we find that firms facing severe market frictions are not as financially constrained as expected. This is because these firms also possess strong PC, which alleviate the costs of market frictions. We find that market frictions can significantly affect financial constraints in Chinese firms, but only for those firms with modest levels of PC.

Tax and leverage: Evidence from China

“…This is because in a transitional economy such as China, governments can interfere with capital allocation. Given that most commercial banks are owned or controlled by central and local governments, banks give preferential treatment to politically connected firms as a form of political rent, e.g., allocating more funds to such companies (SeeWu & Yue, 2009;Deng, Zeng, & Zhu, 2017).3 For example, by hiring a retired official who can exert his influence to obtain more bank loans through the political network he established before retirement(Lin, Morck, Yeung, & Zhao, 2016). 4 Attempts in the literature to answer this question (e.g.,Booth et al, 2001; Fan, Titman, & Twite, 2002;Giannetti, 2003;De Jong, Kabir, & Nguyen, 2008) suggest that institutional differences cause variations in capital structure decisions across countries.…”

Political embeddedness and firms’ choices of earnings management strategies in China

“…First, politically connected managers may have strong incentives to manage earnings to increase the firm's financial performance because it is closely related to their reputation and political career (Li and Zhou, 2005). Second, PCEs may have strong incentives and opportunities to manage earnings to mask benefits derived from political connections, such as easier access to bank loans with lower interest rates (Khwaja and Mian, 2005;Faccio, 2006;Boubakri et al, 2008;Deng et al, 2019), government subsidies (Wu and Cheng, 2011), favourable tax rates (Wu et al, 2012b), regulatory treatment (Agrawal and Knoeber, 2001;Han and Zhang, 2018) and bailouts (Faccio et al, 2006). Third, corporate executives with political connections have strong incentives and opportunities to achieve political and personal objectives, such as promotion and increased remuneration, and conceal private benefits (Shleifer and Vishny, 1994;Li and Zhou, 2005).…”

“…Thus, politically connected managers have strong incentives to pursue financial benefits to achieve personal objectives, such as promotion (Shleifer and Vishny, 1994) and increased remuneration, and conceal private benefits (Shleifer and Vishny, 1994;Li and Zhou, 2005). The motives behind the incentives to pursue financial performance also include masking benefits derived from political connections (Agrawal and Knoeber, 2001;Faccio et al, 2006;Wu and Cheng, 2011;Wu et al, 2012b;Deng et al, 2019). Under such 'extra performance pressure' and stronger motives to hide political favours, politically connected managers prefer real to accrual-based earnings management strategies, so much so that PCEs' earnings management substitution could lead to more total earnings management.…”

“…Via de facto control of these firms (i.e., the ability to direct a company to act on the government's behalf), the government can directly influence corporate behaviour (Chen et al, 2011b;Wu et al, 2012a). Furthermore, due to the appointment of top executives by the government, and the executives' pursuit of political careers, extensive political connections between the government and the senior management of firms are still very common (Fan et al, 2007;Li et al, 2008;Liu et al, 2017Liu et al, , 2019Han and Zhang, 2018;Peng et al, 2018;Deng et al, 2019). These political network connections are likely to indirectly influence the connected firms' reporting behaviour.…”

The ISIS Impacts on the Political Connections, Board Interlock, and Quality of Financial Reporting

“…In addition, what will be the effect of Islamic State of Iraq and Syria (ISIS)'s interactive variable on the relationship between the solidarity of board members and the quality of financial reporting and the relationship between political communication and quality of financial reporting? Prior studies such as Carrington (1981) in Canada, Meeusen and Cuyvers (1985) in Belgium, Keister (1998) in China, Peng et al (2015), Pan andTian (2017), andDeng et al (2019) have considered the relationship between PR and its effect on the profit or the relationship between director's interlock and firm performance. No research has ever examined the relationship between political matters and Binter.…”