Communist party direct control and corporate investment efficiency: evidence from China^*

* Accepted by Yue Ma upon recommendation by Junbo Wang

Abstract

Many communist countries, such as China, place emphasis on fixed-asset investments in their process of economic development. Governments push the policy using state-owned enterprises (SOEs) via a communist party committee (CPC). Political and agency costs make SOE investment sub-optimal. We examine the impact of firm-level CPC control on the investment efficiency among a sample of Chinese SOEs. We test agency problem overhaul and political entrenchment hypotheses. The results suggest that CPC control, in terms of having a CPC member as a director, supervisor, or senior executive, can improve investment efficiency, especially for overinvestment in SOEs. Our findings are robust to different measures of overinvestment and are more pronounced among locally controlled SOEs and SOEs with CEO/board chairman duality. Overall, our findings support the agency problem overhaul hypothesis. The involvement of a CPC member in the control of an SOE, on average, mitigates the agency cost and more than offsets the additional political cost incurred.

Keywords:

• Communist party control
• agency cost
• investment efficiency

Notes

* Accepted by Yue Ma upon recommendation by Junbo Wang

1. China has a dual board system. This system has a board of directors and a board of supervisors. The board of directors advises the firm on operations, while the board of supervisors fulfills monitoring duties.

2. According to World Bank statistics, China had annual GDP growth rates of 9.5, 7.8, 7.7, and 7.3% in 2011, 2012, 2013, and 2014, respectively. (http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?order=wbapi_data_value_2012+wbapi_data_value&sort=asc; accessed March 7, 2016).

3. Some non-SOEs also have CPCs. We do not include non-SOE in our study for two reasons. First, CPCs are more important in SOEs than those of non-SOEs. In SOEs, there are specific rules and organizations in a CPC to empower CPC members so that they can execute related policies to SOEs. In non-SOEs, however, it is not clear if CPC members receive similar empowerment. Second, the proportion of non-SOEs that has CPCs is low. After checking the data, the proportion of non-SOEs with CPC members as director, supervisors, and senior executives are 0.9, 0.4, and 0.4%, respectively. With a sample of 7,581 firm-years from non-SOEs, such a sample amounts to 68, 30, and 30 firm-years. Hence, there will not be any meaningful conclusions drawing from the small sample analysis of non-SOEs with CPC members exercising direct control.

4. We measure underinvestment as the absolute value of the negative residual from Equation (1).