Political Connections And Soft Budget Constraints Of Private Enterprises

Debt financing can reduce manager's free cash flow, increase business risk and strengthen supervision and inspection role of the debtor to reduce agency costs and improve efficiency of corporate governance. But the effects of debt financing are based on "hard" budget constraints. Dewatripond and Maskin (1995) found that debt financing was not valid under the soft budget constraints. In emerging market economies, soft budget constraints are particularly prevalent. The establishment and development of China's capital market is completed under the guidance of the government. Besides, there are homogeneous property rights between state-owned listed companies and state-owned commercial banks. As a result, the budget constraints of state-owned enterprises become "soft". As independent market entities, private enterprises enjoy distinct property rights, the budget constraints is generally considered "hard", and debt financing governance is effective.However, in recent years, with the vigorous development of private economy, private entrepreneurs participate more in political affairs. It's getting much more popular that private companies are developing their political connections. Political connections as an alternative market mechanism can bring the enterprise financing facilities, tax incentives, market forces, and many other advantages. Thus, the following questions arose my interest. First, are there soft budget constraints in private enterprises? Do political connections affect the soft budgets constrains of private enterprises? How different levels of political connections affect the soft budget constraints of private enterprises?Based on corporate governance theory and economic theory of property rights, we studied the above-mentioned three issues using observations of1087non-financial private enterprises listed in Shanghai and Shenzhen Stock Exchanges. The results show that:First, Soft budget constraints do exist in Chinese private enterprises; Second, political connections will strengthen the soft budget constraints of private enterprises, and the soft budget constraints of listed private enterprises with political connections is stronger than those without political connections; Third, Different levels of political connections have different effects on the soft budget constraints of private enterprises. As the level of political connections increases, the degree of soft budget constraint gets higher.Finally, based on the study, we believe that by speeding up China's bank reforming process, promoting the development of bond markets, regulating government's economic behavior, and improving the bankruptcy system along with other measures, can we help ease the soft budget constraints of private enterprises. The main contribution of this paper is that based on political connections of private enterprises, this paper re-examines the budget constraints of private enterprises. It provides a new perspective for the study of the cause of soft budget constraints of private enterprise. Last but not least, it enriches and develops the mechanism of how political connections effect firm value.