A Study On Government Intervention, Political Connections And Firm Value In China

In the process of world economic development, political connections become universal phenomena all over the world and widely exist in most countries. Especially in recent years, political connections have become a hot research field and a frontier topic of corporate finance. Political connections originate from government's intervention in macro and micro economy, and similar to government's intervention, they also have two opposite economic effects:the grabbing hand and the helping hand. In China, because of its special political and economic environment, governmental intervention in business activities is very serious. Meanwhile, many listed firms have developed complex and diversified associations with government through various ways, and enjoyed easier access to debt financing, lower taxation, and stronger market power. By means of bank loan, tax, corporate government, tunneling and etc., political connections can impose significant impact on almost all aspects of enterprise operation and management, and consequently affect firm valuation. Based on the overview of research on government intervention and political connections at home and abroad, and rooted in China's unique institutional background, this paper explores the role of government intervention and political connections from the perspectives of financing constraints, capital cost and corporate performance, and focuses on examining the influence of government intervention and political connections on firm valuation under different ultimate ownerships conditions.Using a sample of Chinese A-share listed firms during 2004-2006, this paper adopts the method of multiple discriminant analysis, to analyze the listed firms'present situation of financing constraints. Further, this paper sets up an empirical model of cash and cash flow sensitivity, presented initially by Almeida et al., to study in depth the effects of political connections on financing constraint and financing ability of private firms and state-owned enterprises. The results show private firms suffer higher financing constraints than state-owned enterprises. Moreover, indirect-listed private firms are more likely to be financially constrained than direct-listed private firms. Political connections can significantly reduce financing constraints of private firms. But it is helpless to promote the growth of financing abilities of state-owned enterprises, which is most attributed to the governmental background of large shareholders. Government ownership enables state-owned enterprises to take advantage of soft constraints in bank loans, thus the role of political connections is weakened and insignificant. After considering the strength of government intervention in different provinces, empirical results show that in provinces with higher governmental intervention on the economics sectors, political connections have more obvious effects on financing constraint of private firms. However, this effect is not reflected by state-owned firms.This paper examines the effects of government intervention and political connections on cost of equity capital in China, by using a sample of 334 A-share listed firms launching share placement during the period of 1999-2001. The research finds that there is significant negative influence of government intervention on the cost of equity of state-owned enterprises. For the state-owned sample, there is no significant relationship between political connections and cost of equity. However, for the sub-sample with higher governmental intervention, political connections significantly increase the cost of equity. Moreover, for the non-state sample, political connections also have negative impact on the cost of equity. These results suggest political connections bring even higher risks to the majority of firms. The reason is that government intervention and political connections both have two opposite effects on enterprise risks. One is to increase the predictability of operation behaviors and business environment and consequently decrease cost of equity. The other is cost of equity will be increased without government protection. These two effects are offset by each other, eventually the net effect is investors increase the evaluation of enterprise risks, and therefore increase the cost of equity. Based on Cob-Douglas production function, this paper establishes a stochastic frontier model to test the data set of more than 1000 private listed firms. This paper divides private firms into direct listed firms and indirect listed firms, differentiates their ways to establish connections with government, then analyzes the relation between political connections and market valuation of private listed firms. The empirical results show that direct listed private firms have stronger motivation to construct political connections, and then have higher market valuation than indirect listed private firms. Political connections have no significant effect on the valuation of direct listed firms, but it has significantly negative impact on the valuation of indirect listed firms. A reasonable explanation is that grabbing hand following political connections is more pronounced in the sub group of indirect listed firms. The differences lie in that two types of firms have different motivations and ways to establish their owners'political connections.This paper not only deeply extends the theoretical study on government invention, but also provides valuable empirical evidences for the debate on whether political connections will increase or decrease firms valuation. The results confirm that both government invention and political connections indeed do harm to the interests of shareholders as a whole, but the improvement of institutional environment can reduce such negative effects. This research deepens our knowledge and understanding about the mechanisms and economic effects of government invention and political connections, therefore has important theoretical and practical significance. The research aims at throwing light on China's policies, and discloses that China should further promote political and legal institution building, reduce motivation of government intervention and squeeze the space of enterprises rent-seeking, and finally realize social fairness and healthy development of economy.