China’s subnational governments (e.g., provinces, cities/municipalities, counties, and townships) often control important resources, including land, loans, energy, permits, and raw materials. Firms that have built ties with local government officials enjoy benefits, such as preferential access to financing and tax advantages, that can enhance their operations and increase the value of their firms. After political turnovers, however, firms risk losing the benefits associated with established connections. How is the relationship between firms and local government officials built in China following political turnovers?  

The data. Researchers gather data on publicly listed firms on the Shanghai and Shenzhen Stock Exchanges in China from 2007 to 2018. Additional financial data come from the China Stock Market and Accounting Research database and the National Bureau of Statistics. The researchers collect political turnover data on city-level Party Secretaries and mayors from official city government websites, identifying 1,098 new Party Secretaries and 1,372 new mayors. They use a firm’s reported perk spending — entertainment and travel expenses — as a proxy for relationship-building activities with newly appointed officials. To analyze changes in perk spending following political turnover, they merge the personnel data of officials with firm-level financial data, matching by province, city, and fiscal year, resulting in 6,541 firm-year observations.

Firms invest in government relationships following political turnover. In the year after a new Party Secretary or mayor is appointed, a local firm in the city increases its perk spending by about 3.6 million yuan, which is over 20% of the average annual perk spending of 15.3 million yuan. The researchers point out that non-publicly listed firms, which are not included in their sample, likely engage in similar activities. Taken together, the magnitude of perk spending could be significant for a local economy. The increase in spending does not appear to be driven by other possible factors, such as changes in the local economic environment, a firm’s business investment, main customers and suppliers, or the corporate site visits of government officials. 

Perk spending varies by political environment, existing connections, firm ownership type. Perk spending appears to be less affected by political turnovers when it is costlier for officials to accept perks from local firms, for example, after a recent arrest of a local politician in a city, or when the national government’s Central Disciplinary Inspection Team is investigating in the region. The effect of local political turnover on perk spending is also weaker for cases where the incoming official is from the same city. Researchers suggest that in the cases where the incoming official is from the same city, turnover causes fewer interruptions in the existing connections, leading to less need to invest in the relationship. Meanwhile, the effect of local political turnover on perk spending is stronger in areas with more corruption, as measured by a city-level index. 

The effect of local political turnover on perk spending is substantially stronger among private firms, which compete at a disadvantage for favors compared to state-owned enterprises (SOEs). The effect is weaker for SOEs or firms with more politically connected CEOs or chairmen.  

Leadership shuffles at local SOEs follow political turnovers. A change in leadership of a city government official increases the probability of CEO or chairman changes in the city-level SOEs headquartered in that city by 3.3% the next year. This result is driven by the changes at firms that local politicians can influence, such as SOEs controlled by the city government. SOEs, especially those controlled by local governments, are more likely to adopt this approach, likely because they have weaker incentives for profit maximization and face stronger influences from their local governments. The effect disappears, however, among private firms or SOEs controlled by the central government. The results are consistent with the interpretation that, after political turnovers, the connections between governments and local firms are reestablished partly through managerial changes.  

Local government connections important for firm success. The evidence suggests that political turnovers interrupt existing connections between local firms and governments, leading to more relationship-rebuilding activities proxied by an increase in perk spending. The evidence also suggests that SOEs and private firms use different strategies to build relationships with new leaders of the local government, with the former focusing more on personnel-change strategies and the latter on perk-spending strategies. Taken together, the findings indicate that local governments are important gatekeepers and that firms seek to influence them with perks and positions of power within SOEs.