Abstract

Purpose – The purpose of this paper is to research the impact of firms’ political connections on the stock price crash risk. Design/methodology/approach – Empirical methodology is used in this study. Findings – Using a large sample of Chinese firms for the period 2008-2013, the authors find that corporate political connections can reduce the stock price crash risk. When managers are still in politics or firms are in high financial transparency of local governments, the relationship between political connections and the stock price crash risk is weakened. In addition, the authors’ research shows that the corporate political connections influence the stock price crash risk by affecting the speed of confirmation of bad news. Research limitations/implications – The findings in this study suggest that political connections will affect corporate disclosure. Practical implications – These results can help senior executives and investors make better decisions to prevent the stock price crash risk. Originality/value – This paper empirically analyzes the impact of different types of political connections on the stock price crash risk for the first time.

Introduction

China is a typical guanxi-based (i.e. social networks) society. Political connections are arguably the most valuable among all the social relationships. Empirical evidence shows that firms enjoy political connections when the president or chairman of a firm is either a former or a current government official. As an important type of informal institutional arrangements, political ties are widespread in China’s current transitional economic system in China[1]. Corporate behaviors shaped by political connections through senior executives are appealing to academics. In this study, we investigate the economic consequence of political connections. Specifically, we study the impact of political connections on the stock price crash risk. Firms have incentives to appoint executives with political backgrounds as Chairman or CEO to enhance the firm’s competitive advantage. Existing research shows the positive economic consequence of political connections. For example, Jou et al. (2017) find that political connections can help companies obtain external financing from the banks. Yu et al. (2012) and Li and Xie (2014) find that the political background of executives background helps strengthen the resource-seeking ability of private enterprises. Recent behavioral corporate finance literature links political connections to increased tax benefits (Wu et al., 2009), more mergers and acquisitions (Li et al., 2009), greater convenience in bond issuance (Du, 2011), stronger competitive advantages (Faccio, 2006), and enterprise value (Chen, Kim and Yao, 2017; Chen, Li, Luo and Zhang, 2017; Chen, Ghoul and Guedhami et al. 2017). Thus, Zhang and Fang (2013) argue that companies are willing to disclose information to maintain the benefits of such political connections. Most of the existing studies focus on the impact of political connections on firm operations. To the extent that business operations are finally priced into stock prices, we investigate one important dimension of stock price – the risk of future stock price crash.