Research On The Effects Of Political Connections On Firm Investment Efficiency

Starting from the21st century, investment has played an important role in stimulating Chinese economic growth. However, as the economic grows rapidly, the phenomenon of "over-investment" has appeared in some industries. The macro-level "over-investment" is closely related with the micro-level investment inefficiency in firms. Since China is still in the period of transition, factors such as imperfect market mechanism make the government still have a negligible impact on firms’ activities. Many firms tend to establish "connections" with the government in order to have better access to more resources or survive. This linkage can be expressed as direct appointment of executives in state-owned enterprises, i.e., natural "kinship", and can also be expressed as hiring former NPC and CPPCC members, government officials or soldiers to be the executives in private enterprises, or the existing executives participating in politics to actively affect decision-making and the implementation of decisions.The existence of political connections has been worldly confirmed, but the effects of political connections on corporate values and investment behaviors remain inconclusive. On the one hand, political connection is regarded as an alternative non-institutional factor that can help companies gain access to resources, convenient financing, property protection and many other advantages, which would promote firms’investment activities. On the other hand, it could also become the government’s grabbing hand, twisting firms’investment behaviors and decreasing firms’values (e.g., Fan et al.,2007b). In transition economies, this phenomenon is especially significant. This paper used the panel data of Chinese A-share listed private enterprises from2004to2011and applied three regression models (the classic OLS model, Fixed-effect model and Random-effect model) for quantitative comparative analysis to study the effects of political connections on firms’ investment behaviors and investment efficiency.The structure and content of this article are organized as follows:The first chapter is introduction. This chapter is a summary of the background and main content of the paper, specifically including the background of research and raised issues, the study’s theoretical and practical significance, the content and structural arrangements, methods and possible innovations.The second chapter is literature review. This chapter reviews the related literature and theory on political connections, firms’investment efficiency and the relationship between them in order to have an accurate grasp of the development of relevant research. Through the review the paper found the lack of the systematic study of the relation between political connections and firms’investment efficiency, and their methods and conclusions are also different. This paper attempts to supplement this area of research, and enriches the existing theories and research results.The third chapter includes the hypotheses of the impact of political connections on firm investment efficiency. Based on related research, starting from the investment-cash flow relationship, this chapter analyzes the effects of political connections on the investment-cash flow sensitivity, and finally analyzes the impact of political association on investment, gradually making three assumptions.The fourth chapter is research design. This chapter presents the selection of empirical methods, research models, sample selection and data sources, the definitions and measures of variables.The fifth chapter includes the empirical tests and analysis of results. First, employ the descriptive statistical analysis on variables by using the sample and examine the correlation between the variables. Then, plot investment on cash flows by analysis of mean and median investment levels. Afterwards, do the model regression and analyze the results. Finally, test for endogenous and robustness.The last chapter contains summary and prospects. This chapter summarizes the main conclusions, the contributions of the study, the shortages of the research and the prospects for future studies.Through this study, the results show:(1) Chinese private listed enterprises’ investment-cash flow relationship was U-shaped. When there were more internal cash flows (CFs were positive), investment increased as internal funds (net operating cash flows) increased, but when the internal funds were insufficient (there were negative cash flows), firms’investment still increased as cash flows decreased;(2) Politically connected enterprises had higher investment-cash flow sensitivity, and the effects were more significant on the left side of investment-cash flow curve (cash flow was less than zero);(3) When the investment opportunities (indicated as Tobin’s Q) were different, the effects of political connections on corporate investment activities were significantly different, especially when cash flows were negative and firms’investment opportunities were poor. To some extent, political connections led to firms’inefficient investment.This study has both theoretical and practical significances. This paper is first a supplement for related research on political connections. China’s studies on political connections have just started, and many papers focus on government intervention, state-owned enterprises, use outdated survey data or a cross-sectional regression method for analysis, and concentrate more on firm value, but systematic studies on political connections for firms’investment behaviors and investment efficiency are inadequate. Many studies have also ignored the nonlinear relationship between investment and cash flow. This paper considers the U-shaped relationship between investment and cash flow, and employs a comparative analysis of three models, including panel data research approaches. This paper includes the innovation of the application of both models and methods. In terms of the contribution in practical applications, the results of this study are not only the evidence about Chinese excessive investment, overcapacity and other non-efficient investment issues in recent years, but also explains the rapid expansion of private enterprises in China. If the legal and market environment could be more perfect and the economic environment could be more conducive to business growth, non-political connections may be more beneficial to the healthy development of Chinese private enterprises.