Political and Interlocking Connections in the Boardroom on Private Equity Placements

ABSTRACT

This study examines the influence of directors who are politically connected and/or have boardroom interlocking on private equity placements (PEPs) in Chinese listed firms. We document that interlocked directors can significantly influence the propensity to apply for PEPs and approval of PEPs and reduce the cost of PEPs while providing greater access to proceeds from PEPs through lowering information asymmetry and information cost. Although politically connected directors have a significant role in the approval of PEPs, they are more likely to reduce the monitoring effects and increase agency problems, which lead to increased cost of PEPs and reduced proceeds from PEPs. The results also reveal that political connection diminishes the benefits of interlocking directors for firms having directors with both interlocking and political ties.

KEY WORDS:

• agency problem
• information asymmetry and monitoring effect
• interlocked directors
• politically connected directors
• private equity placements

Acknowledgments

The authors are grateful to the constructive comments/suggestions made by seminar participants at Xi’an Jiaotong University, Xi’an International Studies University, and Shanghai University of Finance and Economics, and conference participants at the 12th International Symposium on Empirical Accounting Research in China in Beijing, the Global Finance conference 2015, Hangzhou, China, and AFAANZ annual meeting 2016, Gold Coast, QLD, Australia. We are also thankful to the editor and both reviewers for providing valuable comments and suggestions on our paper.

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Notes

^1. Board interlocks that enable firms imitating diverse contexts including firm political expenditures (Mizruchi 1996), firm philanthropic activity (Galaskiewicz and Wasserman 1989), the spread of antitakeover mechanisms such as poison pills (Davis 1991), firm choices regarding mergers and acquisitions (Haunschild 1993; Renneboog and Zhao 2014), and the CEO searching process (Khurana 2002).

^2. E.g.: stock options backdating (Bizjak, Lemmon, and Whitby 2009) and earnings management (Chiu, Teoh, and Tian 2013; Hirshleifer and Teoh 2009), and the spillover effects of reputational penalties in financial fraud reporting (Kang 2008).

^3. Information asymmetry a major determinant of the discount offered (Erhemjamts and Raman 2012; Hertzel and Smith 1993; Wu 2004). As information asymmetry is expected to be lower for larger (Bhushan 1989; Shores 1990) and older (Berger and Udell 1995) firms.

^4. Information asymmetry is more severe for firms whose value consists mostly of growth potential (Erhemjamts and Raman 2012; Hertzel and Smith 1993). Fraction Placed and BM (the book-to-market ratio of equity).

^5. See note 3 above.

^6. The pooled OLS regression model technique (which includes dummy variables for year and firm fixed effects) is similar to the fixed effects regression model technique, and is used where there is a need to control for omitted variables that differ between cases, but are constant over a time period (Wooldridge 2012). This technique has an advantage for controlling for omitted variables that may be constant over time but vary between cases, and others may be fixed between cases but vary over time (Wooldridge 2012).

^7. We suspect that there are unobservable variables that also affect PEP variables (Discount on PEP and Proceeds from PEP). PC and INTD variables may suffer from omitted variable bias. Hence, the Hausman Test for endogeneity can help us to determine whether or not there is some of omitted variable biased in this regression. The Hausman test confirms that the only INTD leads to endogeneity and detailed results are available from the authors upon request.

^8. Stock and Yogo (2005) suggest an F-statistic in the first-stage regression model of greater than 10 indicates that 10 an IV is not weak. Our F-statistic of 53.69 and 57.33 for INTD_IND therefore shows that it represents a suitable IV.

^9. Stock and Yogo (2005) suggest that an F-statistic in the first-stage regression model of greater than ten indicates that 10 an IV is not weak. Our F-statistic of 53.69 and 57.33 for INTD_IND therefore shows that it represents a suitable IV.

Additional information

Funding

The authors wish to acknowledge the financial support of the China Postdoctoral Foundation (grant number 2016M602786) and National Natural Science Foundation of China (Project No. 70772110).