Who benefits from political connections? Minority investors or controlling shareholders^*

Abstract

Using a sample of Chinese privately controlled firms listed on the Shanghai Stock Exchange during 2003–2012, this paper empirically examines the relation between politically connected independent directors and firm value creation and value expropriation. Our empirical results show that having politicians as independent directors helps listed privately controlled firms to increase subsidies received from the government as well as obtain an ease of access to long-term bank financing. In contrast, we discern that a large fraction of politically connected independent directors increases the magnitude of related-party transactions between the listed firms and their controlling parties, suggesting wealth expropriating from minority shareholders. Finally, when exploring the net effects of political connections, the presence of politically connected independent directors promotes firm profitability and adds residual value to Chinese listed privately controlled firms.

Keywords:

• Political connections
• value creation
• value expropriation
• independent directors
• minority investors

JEL classification:

• G32
• G34
• M14

Acknowledgements

The authors would like to thank Prof. Jeong-Bon Kim and the anonymous reviewer for suggestions that substantially improved the article. The authors acknowledge the National Natural Science Foundation of China (NSFC-71302072), the Research Funds for Outstanding Youth Scholars in Fujian, China (0155-Z0210502), and STF 15002.

Notes

1. One of the salient features of Chinese privately controlled firms is the presence of overwhelming controlling ownership as documented by Jiang and Kim (2014). There is no exception to our sample as we find that 2952 firms out of 2975 firms are tightly controlled by an ultimate controller.

2. According to ‘Section 3, recommendation for establishment of independent director system in Chinese listed firm’ by the China Securities Regulatory Commission (CSRC) in 2001, the following persons should not be classified as independent directors: (1) the relatives of the employees in the listed firm and affiliates. Relatives refers to a spouse, parent, children, brother, sister, parents in-law, son and daughter in-law, brother and sister in-law; (2) persons directly or indirectly holding 1% of the issued shares, or one of the top 10 shareholders, or the direct relative of a top 10 shareholder; (3) the employees and their relatives in companies holding 5% of the issued shares or companies which are among top 5 shareholders; (4) in previous years, the person was classified in category (1) to (3) above; (5) persons providing financial, legal and consulting advice; (6) other persons classified as non-independent directors by the company’s Constitution; (7) other persons classified as non-independent directors by the CSRC.

3. In 2013, both Forbes and Bloomberg listed Mr. Wang Jianlin as the wealthiest person in China with a net worth of US$ 14.2 billion. Before his entry to real estate business, Mr. Wang served in the People’s liberation Army and acted as a deputy to the 17th National Congress of the Communist Party of China. He has been a member of the Chinese People's Political Consultative Conference since 2008.

4. Mr. Wang’s speech is linked in his company’s website, http://www.wanda-group.com/2013/videos_0725/2.html.

5. For example, in 2014, Mr. Liu Han, the former chief of Hanlong Corporation, was a very successful businessman and ranked top 10 in Forbes China. However, he was arrested and sentenced to death after being convicted for bribery and collusion with government officials. He received many benefits from the corrupted politicians who helped him to acquire mining assets at very low prices.

6. A successful business man, at the same time being a government official, is called hong ding shang Ren in China. The literal meaning is a businessman wearing a bureaucratic cap.

7. We also conduct a robustness check and classify privately controlled firms based on their ultimate controlling shareholders types, resulting in 1757 firm year observations (controlled by individual or family trust). The reason is that one may argue that the value creation and value expropriation effect of political connections in different types of privately controlled firms, i.e. firms controlled by individuals vs. other non-government units, may be different. When using a subsample of Chinese listed privately controlled firms controlled by individuals or family trust, we still discern a strong positive relation between politically connected independent directors and the market-to-book ratio. Yet, the relations between politically connected independent directors and the proxies for value creation and value expropriation now become weaker. The outcome of all robustness checks that are not reported in this paper can be obtained from the authors upon request.

8. We have also run the regression models when trimming the data. Our main conclusions regarding the associations between political connections and value creation and value expropriation remain valid.

9. To test whether firms with politically connected independent directors are more likely to get benefits (such as subsidy) from the government and then allocate the benefits to other related parities, we also examine the interactive effect between POLCON, and subsidy and long-term bank loans on RPT. We observe a strongly positive relation between subsidy and RPT, while long-term bank loans do not bear a relation with RPT. Yet, for the interaction terms, we do not observe strong interactive impacts, i.e. POLCON*subsidy and POLCON*long-term bank loans, on RPT.