How do political connections mitigate policy uncertainty? : evidence from Chinese real estate firms

Abstract

It is important for firms to build relationships with the government in both developed and developing economies, and the relationships are generally regarded as political connections. Numerous studies have documented that political connections bring benefits to firms, while other studies also show that the corporate political activity signifies a huge cost to firms. This thesis investigates the importance of political connections in protecting real estate firms under policy uncertainty. Policy uncertainty reflects the uncertainty regarding the contents and potential effects of policy announcements. While policy uncertainty is usually measured using either stock market volatility, or the index developed by Baker et al. (2016), this study utilizes a novel approach by introducing a series of policy shocks related to the real estate industry in China to serve as exogenous sources of uncertainty. Specifically, this study collects policy announcements regarding the real estate sector over the period of 2010 to 2016, and conducts an event study on how political connections mitigate the negative effect of policy uncertainty. The findings show that political connections are positively associated with firms’ cumulative abnormal returns under these policy events. This study further finds that the value of political connections is related to firms’ information advantage and political influence in the environment of policy uncertainty. Moreover, this study identifies the type of political connections that is more valuable in coping with policy uncertainty. This study finds that political connections are more beneficial to non-SOEs than SOEs, and the founder’s political ties are more valuable than other directors’. This study further provides a series of additional analyses. Using the Regulation 18 which is a part of the anti-corruption campaign in China, this study finds that the mitigating effect of political connections under policy uncertainty is significantly reduced in the post-Reg. 18 period. This study also finds that the mitigating effect of political connections is more pronounced for firms in regions that are presumed to have weaker market institutions with less property right and investor protections, for firms spending more entertainment and travel costs, and for firms during the period of low policy uncertainty. Moreover, this study finds consistent evidence that can support the findings using a battery of robustness checks. Political connections become especially vital in a transition economy such as China, where relationships or “guanxi” takes pivotal roles in business transactions due to the lack of institutional support and property right protection. Nonetheless, the findings provide implications that political connections protect firms against policy uncertainty only under specific conditions.