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Do political connections affect stock price crash risk? Firm-level evidence from China

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Abstract

Using a sample of Chinese listed firms in the period from 2003 to 2012, this paper empirically investigates how the presence of politically connected directors affects stock price crash risk. We thereby make a distinction between listed state-controlled firms and privately controlled firms due to their different incentives to appoint politicians as directors on the board. Our empirical results show that politically connected directors exacerbate stock price crash risk in listed state-controlled firms, an effect driven by the appointment of local government officials as directors. In contrast, hiring politicians as directors, particularly central-government-affiliated directors, helps listed privately controlled firms to reduce stock price crash risk. Finally, good quality of institutions does not help to alleviate the positive relationship between political connections and stock price crash risk in listed state-controlled firms. However, it does weaken the role of political connections in reducing crash risk in listed privately controlled firms.

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Notes

  1. Moreover, Berkman et al. (2010) document that in the Chinese stock market, regulations intended to protect minority rights are much less effective in companies with a closer tie to the government. They attribute this finding to the fact that investors do not expect regulators to enforce these rules when the firms are closely connected with the government. Furthermore, Tang et al. (2011) find a positive relationship between political connections and stock price synchronism in China. They explain that political connections might lead to financial opacity because activities between connected firms and the government are often nonpublic or cannot be revealed.

  2. Among them, Wu et al. (2012) provide evidence demonstrating that political connections, measured as politically connected managers, exacerbate the over-investment problem in state-owned enterprises but bring about tax benefits for privately controlled firms. Wang (2015) examines the presence of politically connected independent directors in the Chinese listed sector and finds that politically connected independent directors exacerbate the over-investment problem in listed SOEs, and they do not help to promote firm value, indicating an expropriation of minority rights. In contrast, in listed privately controlled firms, the presence of politically connected independent directors is associated with an ease of access to external financing and government subsidies and a higher firm value, suggesting a helping hand from the connection with government.

  3. Empirical studies also provide some support to this argument. Fan and Wong (2002) demonstrate that the tunneling incentive of a controlling shareholder, measured as the separation of cash flow rights from control rights, will result in less informative earnings. Attig et al. (2006) find that information asymmetry is more severe and stocks are less liquid in firms that have a conflict of interest between large and small investors. Most recently, both Gul et al. (2010) and Boubaker et al. (2014) recognize that the possibility of an entrenchment effect by controlling shareholders will cause stock price synchronicity.

  4. These five fields include (1) the relationship between the government and the market, (2) the development of the non-state sector in the economy, (3) the development of the product market, (4) the development of the factor market, and (5) the development of market intermediaries and the legal environment. An early version of these data has been used in other studies, including for example Li et al. (2009), Ayyagari et al. (2010), and Huyghebaert and Wang (2012).

  5. We have also run the regression models with trimming the data. Our main conclusions concerning the associations between politically connected directors and stock price crash risk remain valid. The outcome of all robustness checks not reported in this paper can be obtained from the authors upon request.

  6. We also re-do the analysis by adding 204 observations in 2013 to the full sample. These observations are less affected by the prohibition of politicians as independent directors in October 2013. Our empirical findings on the relationship between politically connected directors and stock price crash risk remain robust in this additional test.

  7. We also use three alternative measures on the quality of institutions to redo the tests (see also Sect. 4.2.3). The empirical results are consistent with those reported in the paper.

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Acknowledgments

The authors would like to thank the editor and three anonymous reviewers for suggestions that substantially improved the article. We also would like to thank Chin Man Chu, Wenzhou Qu, Terry Walter, Ji George Wu, and participants in the 2014 International Conference on Corporate Finance and Capital Market (Hangzhou) for their suggestions and comments on an earlier draft of this article. Lihong Wang acknowledges the National Natural Science Foundation of China (NSFC-71302072) and the Research Funds for Outstanding Youth Scholars in Fujian, China (0155-Z0210502) for financial support.

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Authors and Affiliations

  1. Nanyang Business School, Nanyang Technological University, Singapore, Singapore

    Wei Lee

  2. Institute for Financial and Accounting Studies, Xiamen University, Siming Nanlu 422, Xiamen, 361005, China

    Lihong Wang

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  1. Wei Lee
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Correspondence to Lihong Wang.

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Lee, W., Wang, L. Do political connections affect stock price crash risk? Firm-level evidence from China. Rev Quant Finan Acc 48, 643–676 (2017). https://doi.org/10.1007/s11156-016-0563-3

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