Employee Stock Options, Political Connections and Regulation Change in Chinese Listed Firms

Motivated by the institutional setting and based on the extant literature, this paper investigates the effects of changes in the regulation of employee stock options (SO) and political connection (PC) on SO grants (size-SOP and value-SOM) and the moderating effects of changes in ESO regulations on the relationship between political connections and SO grants. Using the established measurements of stock option grants, political connection and stock option regulation change (REG), we analysed the final sample of 482 firm-year observations from 190 firms from 2006 to 2018, obtained from Chinese listed firms. Empirical analysis using pooled ordinary least squares (OLS) and Fixed Effect (FE) regression model with robust standard errors was used for analyzing the data. To mitigate self-selection bias, we used the propensity score matching (PSM) method. To address endogeneity (i.e., causality and/or simultaneity) and for robustness tests, we used 2SLS regression analysis with instrumental variables to check the moderating effect of regulation change and PC on the relationship between PC and SOs granted (SOP and SOM). We find that the implementation of SO regulation changes has a negative effect on SO grants in terms of both size and value, while PC has a positive effect. Change in the ESO regulations negatively moderated the relationship between PC and ESO grants. This suggests that PC led to increased SO grants before the regulation change, but a tightening of ESO regulations attenuated this relationship after 2009. PC firms granted significantly more and higher-valued stock options to employees than unconnected firms, but this trend declined after the reform. These findings provide crucial insights for managers, market regulators, and investors in enriching effective stock option regulation processes and understanding the impact of PC on stock options in China. The study also offers policy implications for policymakers and regulators.