Size-expansion And Efficiency-impairment:the Impact Of Chinese Private Enterprises’Political Connection On Firms’ Development

Althogh more than30years has been past since the1978economic reform, the private enterprises in China are still at the bottom of the "political pecking order" of resource allocation, and therefore facing harsh institutional obstacles in terms of firm growth. In order to gain access to resources which are of vital importance to firm growth, private enterprises choose to establish intimate tics with the government. This phenomenon has attracted great attention of scholars. However, under the commonly employed "helping hand or grabbing hand" classic analytical framework, which originated from government theory, the major focus of current literature is "what benefits or costs would political connecetion bring to the enterprises". As to (1) how would political connection reshape firms’ decision-making behaviors,(2) what role does a political connection play in firms’ management and development, and (3) the mechanism through which political connection influences firm value, we have merely limited knowledge.In order to answer these questions, this dissertation builds up an enterprise perspective analysis framework, named "size-expansion effect—efficiency-impairment effect" framework. Taking that political connection would bring private enterprises more resources as granted, our analysis focus on firms’endogenous reaction to political connection’s resource effect, ie what changes would happen to firm behaviors once political connection is established. The theoretical conclusions are as follows:There are mainly two channels that contribute to political connection’s resource effect. Firstly, political connection could facilitate enterprises’ability to obtain financial support and thus relieve their financing constraints. Secondly, political connection could help enterprises break through barriers to entry and thus get into industries with high profits. Given its resource effect, political connection would profoundly reshape firms’ decision-making behavior, and therefore significantly affect firms’ management strategy and development, which has two distinct manifestations. The first one is what we described as size-expansion effect:by getting enterprises involved in more profitable business and ensuring them of plenty funds, political connection benefit enterprises with increased investment and firm size. The second one is what we described as the efficiency-impairment effect: political connection would lead to the loss of firms’production efficiency. The reason is that attention and energy that entrepreneurs devoted to productive activities would be queezed out by the connection building and maintenance, the innovation incentive would be weakened, and the policy burden will be aggravated.The mechanism that political connection influences firm value could be attributed to the mentioned two opposite effects:the size expansion effect and the efficiency effect, respectively. The size-expansion effect will increase firm value while the efficiency-impairment effect will decrease firm value. Whether political connection will increase or decrease firm value depends on which effect is taking the dominant place. Our analysis reveals that the size-expansion effect dominates the efficiency-impairment one, owing to the fact government still plays a decisive role in allocation of resources. Entrepreneurs are strongly motivated to compete for resources, and would like to enlarge firm size even at the cost of efficiency.In the subsequent empirical study, by using a unique unbalanced panel dataset of accounting and political connection data for listed Chinese private companies and taking advantage of rigorous econometric methods, we provide sound empirical evidence for the aforementioned "size-expansion effect-efficiency-impairment effect" analytical framework. Firstly, by applying the "cash flow sensitivity of cash" financing constraints identification strategy, we figure out the mechanism that political connection relieves firms’ financing constraints, and therefore confirm the resource effect of political connection. Secondly, through the investigation of the influence of political connection on firm investment and firm growth, we verify the size-expansion effect of political connection. Thirdly, within capital productivity, labor productivity and SFA productivity measurement framework, we check how political connection affects firms’ productivity efficiency, and therefore prove the efficiency-impairment effect of political connection. We also validate that the size-expansion effect indeed dominates the efficiency-impairment one, so it is rational for private enterprises to establish political connection. Furthermore, as an extension of the "size-expansion effect—efficiency-impairment effect" framework, we provide conclusive empirical evidence that political connection actually reduces firm performance, measured by ROA and ROE, which is the immediate consequence of the politically connected enterprises’developing strategy which overemphasize size-expansion, rather than efficiency-enhancing. This helps to clarify the debate about whether political connection improves or depresses firm performance.As for private enterprises in China, the political strategy is now over extensively adopted as a business strategy. Due to resource effect of political connection, private enterprises would rather enhance firm value through size expansion than improve the core competitiveness through management and technical innovation. This is a pragmatic choice for entrepreneurs in China’s current business environment. There is no denying that political connection has played considerable positive impact on private enterprises’growth, but its negative influence on enterprises’behavior distortion should by no means be neglected. In the long run, the private enterprises will not only fail to build up core competitiveness, their original efficiency advantage will also be lost, and finally be locked in a path of development which is heavily relationship and resource dependent. Such a distorted business strategy is definitely unsustainable, neither viewed from the microscopic perspective of enterprises’ development, nor from the macroscopic perspective of private economy growth and even the national economy growth.Enterprises’ behavior distortion ultimately lies in the deeply government’s excessive intervention in the micro economic operation and resource allocation, so that private enterprises have been treated severely unequally. In order to reverse those distortion, the authority should strengthen the system construction, create a better performing institutional background for private enterprises, particularly, provide all the enterprises equal access to resources. To build fair market environment and eliminate policy discrimination, the foremost task is to clarify the boundary of the government and the market and let market mechanism plays the fundamental role in resource allocation.