Political connection formation and firm performance: Evidence from China

This paper investigates the relationship between political connections and firm performance by exploring the mechanisms underneath political connection formation and the determining factor(s) of these mechanisms. We argue that there are two mechanisms, promotive and exploitative, upon which political connections are formed, and these mechanisms are determined by connecting officers’ exploitative power: Political connections with political officials who have strong (weak) exploitative power are more likely to be formed upon the exploitative (promotive) mechanism. Political connections formed upon the promotive mechanism positively affect connected firms’ performance, while the influences of those formed upon the exploitative mechanism are negative. Using China's recent Anti-Corruption Campaign as a natural experiment, we test our arguments using a comprehensive data set on publicly listed non-state-controlled firms in China from 2008 to 2016 and find evidence supporting our arguments. Our findings provide explanations to why previous literature finds conflicting results on the influences of political connections and why firms hold political connections that negatively affect their performance. Our empirical results also show that political connections with executive-branch political officials tend to negatively influence connected firms’ performance, and the influences of political connections with legislative-branch political officials tend to be positive. This finding not only suggests that policies restricting executive-branch political officials’ exploitative power may help improve firm performance but also highlights the importance of considering the heterogeneity between political connections in different branches when studying the interactions between industries and government authorities. This heterogeneity has been under-considered in extant literature.