The Impact of Banning Officials from Corporate Boards in China
The Impact of Banning Officials from Corporate Boards in China [ 5 min read ]
Insights
- In 2013, China barred officials from serving on corporate boards, causing tens of thousands to step down from such posts in subsequent years.
- By comparing outcomes among private firms before and after politically connected directors stepped down, researchers find that the departures initially caused a 1% decline in firm value and a rise in their cost of debt relative to unconnected firms.
- However, over time, firms that lost their politically connected board members became more productive, transparent, and innovative, while also regaining their value.
- Taken together, the evidence suggests that reductions in corruption can boost the long-term competitiveness of China’s private firms.
Source Publication: Daniel Berkowitz, Chen Lin, and Sibo Liu (2021). De-politicization and Corporate Transformation: Evidence from China. Journal of Law, Economics, and Organization.
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Political connections can have value for firms because they provide government concessions, such as favorable regulations, government contracts, lower-cost finance, and bailouts. Shortly after China launched an anti-corruption campaign in 2013, China’s Central Organization Department, the top-level authority in charge of Communist Party personnel arrangements, announced a regulation barring public officials from holding directorships on corporate boards. Tens of thousands of government officials subsequently relinquished corporate posts, including over 200 provincial and ministerial level officials. How has their departure affected the subsequent value and performance of China’s private firms?
The data. Researchers used the China Stock Market and Accounting Research and WIND databases to obtain firm-level financial variables, the biographies of independent directors, and stock prices for A-share stocks listed on the Shanghai and Shenzhen stock exchanges for a sample of over 1,100 private firms between 2007 and 2019. They cross-checked the biographies and resignations of independent directors with company disclosures and other online sources to measure the political connections of directors. Directors were considered politically connected if they held a position as a government official in the three years prior to 2013.
They then compared firm value (measured by stock prices), preferential access to finance (measured by cost of debt), transparency (measured by related party transactions), and operational efficiency (measured by total factor productivity) before and after the resignation of politically connected directors. Researchers also measured changes in innovation, measured by a firm’s research and development investment and its efforts to acquire advanced machinery, which researchers assessed using import and export transaction data from the China Customs Database.
In the short term: firms lose value, cost of debt rises. The stock market value of firms that had officials as board directors prior to the new regulation declined by an average of 1% when compared with unconnected firms, suggesting that political connections did indeed have value. Similarly, politically connected firms often enjoyed lower borrowing costs from banks. Researchers found that when firms lost political directors, they also lost their preferential access to finance: their cost of debt (interest expenses divided by average total loans) increased by 1.1 percentage points, an amount equal to roughly 9.5% of the variation from the average loan cost in the sample.
In the longer term: firms operate more competitively. Past research has shown politicians in China are rewarded with promotion when they successfully deliver local GDP growth. This may cause them to promote shorter-term pet projects rather than longer-term strategic investments. Consistent with this view, after losing their politically connected directors, firms tend to invest in activities that make them more competitive over the longer term.
Specifically, one year after losing their politically connected director, the researchers found that firms prioritized innovation by importing more advanced machinery. Firms also increased their transparency by reducing transactions to “related parties,” such as major shareholders or other insiders and their relatives, suggesting a decline in (sometimes inefficient) rent-seeking behavior. These firms also saw gains in total factor productivity, a common measure of operational efficiency. Within two years, firms’ cost of debt had recovered. Within three years, firms were investing more in research and development, and their market value bounced back from the losses borne when the regulation was announced.
Severing political connections can lead to healthier firm growth. The results suggest that removing officials from boards could allow firms to shift their focus away from emphasizing pet projects or favors to insiders toward activities that promote long-term competitiveness. These findings are consistent with the view that when a reform is part of a broad and credible government commitment to reduce corruption, it is possible to eliminate political connections in private firms and stimulate them to adjust in ways that promote economic growth.