Relative to unrelated firms, "princeling" affiliated firms (PLGs) experience higher cost of sales than unrelated firms, but still earn better operating profits. This study first analyzes whether princeling-linked firms (PLGs) have greater operating performance and growth opportunities than matching firms. This finding is consistent with previous research suggesting that building and maintaining political ties; affiliated companies in China incur greater expenditures on social activities and entertainment (Liang and Chen, 2012).
In order to build and maintain political ties, connected firms have a desire to reward their supporters by "gifting". In addition, connected companies have a higher average (median) net operating cash flow (NOC) than non-connected companies, by 1.5%. In addition, affiliates have significantly (by 1%) greater cash received from sales and merchandise (OCTA) than nonaffiliates.
The average (median) of "selling expenses" for related firms is higher than for unrelated firms, with a difference of However, when comparing retained earnings, the difference between affiliated and non-affiliated firms is found to be disproportionately high (7.5% versus 4.6% on average). These initial findings are consistent with the suggestion that larger retained earnings may provide related firms with opportunities for potential private benefit extraction.
This evidence suggests that connected companies have performed differently since 2001, the year China first joined the WTO.
Multivariate analysis
- Hypothesis 1: Political connections, operating performance and growth opportunities
- Hypothesis 2: political connections and Selling expenses
- Hypothesis 3: Political connections and profit allocations
- Unsolved Puzzle in Retained earnings
This is consistent with the conclusion drawn from the observed difference in retained earnings (Figure 1.C). Taking into account the distribution of these profits, the univariate comparisons of dividend payments, retained earnings and surplus reserves show a large difference in retained earnings but not in the level of dividends paid. It also includes a set of variables to control for board characteristics; the number of directors on the board (Board), the number of independent directors (Independent), the average director age (Age), the average score of director education level (Education), and the background of directors (Background).
The focus in this study is on the coefficient, which measures the sensitivity of performance and expropriation to firms' political connectedness. The ownership variable controls for the possibility that a politician's rent-seeking incentives depend on the controlling shareholders' ownership interest in the firm. Additionally, board properties are controlled using the following variables; Board is the log of number of board directors, Independent is the percentage of independent directors on the board, Age is the average age of directors on the board, Education is the average education level of directors on the board, and Background is the number of directors who previously attended universities. whether research institutions have worked or are currently working.
The coefficient on the dummy variable PC is positive and statistically significant across all specifications, at. According to this view, firms' accumulation of earnings is more or less automatic because sufficient retained earnings can provide a cushion for unexpected events, such as a global crisis. The negative relationship between fixed assets and retained earnings does not support an investment motivation.
Nevertheless, when precautionary motives are controlled, a positive relationship between PC and retained earnings remains in model 5 (1% significance level). Overall, the results in Table 5 are consistent with the proposition in Hypothesis 3 that firms with princely connections maintain higher retained earnings and lower cash dividends. Any adjustment for changes in retained earnings allowed by accounting rules must also include this in the equation.
The above results provide a more detailed picture of lower dividends and higher retained earnings in PLGs. The average politically connected company produces more net income and pays out a smaller portion of it as dividends, leaving a larger portion in retained earnings. According to the balance sheet, the higher accumulated retained earnings among PLGs could be reflected in the asset accounts growing larger than the non-PLGs, the liability accounts declining faster than those of the matched companies, or the other equity accounts declining.
Time trend analysis
The average ∆RE in affiliated companies of 132.45 million RMB is 1.92 times more than that of non-affiliated companies. Nevertheless, we can shed light on this by observing the timeline of political connections. This difference supports the notion that PLGs outperform non-PLGs through operational performance after being selected by princelings.
The sharp increase supports the idea that princely connection introduced some new value into the connected firms. In other words, the potential concern for the regression is that political connections may not be exogenous. This study attempts to resolve endogeneity issues by examining the time trends in the changes of accounting performance.
Specifically, it covers a sufficiently long time horizon from 1993 to 2011 to provide us with a greater variety of information that reflects the dramatic changes that have occurred in politically connected companies. For example, firms may be more likely to seek political connections when they lack managerial or production efficiency but gain their competitive advantage through political connections or direct bribery. In this scenario, political connections would lead to differences in firm performance before and after the establishment of political ties.
If so, we can find time trend changes in the accounting performance of member firms. If so, the political connection is an expected risk with no economic outcome, and as such, no changes may be observed in the accounting performance of affiliated firms relative to the matched firms over time. In contrast, if we look at the timeframe from around 2000 onwards, the ratios for PLGs are generally higher than those for unrelated companies, with the differences remaining consistent from 2001 onwards.
The systematic differences in operating performance between PLGs and the corresponding unrelated firms in operating performance are consistent with a view that the superior performance of PLGs is the result of political connections. As mentioned in section 3.3.3, PLGs that have accumulated higher retained earnings should have a mirror reaction in increasing asset accounts, decreasing liability accounts or reducing other equity accounts. We observe that PLGs have higher current assets and lower total current liabilities than non-PLGs after 2001, again consistent with the time pattern in ROA (C).
Conclusions
Moreover, the equity capital in both PLGs and matching firms decreased during the sample period of 1993-2011. For example, one possible explanation is that PLGs buy back shares to drive share prices up, which in turn rewards investors with capital gains. This finding suggests that PLGs are more affluent compared to their peers, which means that the principal connection is valuable.
In line with LLSV (2000), this paper finds that PLGs pay lower cash dividends and thus retain disproportionately larger retained earnings that are neither used for investment opportunities nor for precautionary reasons. To better understand the motives behind the accumulation of retained earnings, this study analyzes the components of retained earnings during the distribution of earnings and finds that PLGs have higher changes in retained earnings but lower changes in cash dividends than unrelated firms3. Nevertheless, none of the evidence presented here is consistent with the misappropriation of assets by PLG insiders.
Since it is not possible to infer any causality from the reported results of the OLS regression, this study also examines the time trend of the key variables used to test the hypotheses in this article. The systematic patterns observed from the time trends support the idea that political connections influence firms' operations and profit allocations. PLGs have systematically performed differently than unrelated companies since 2000, when China experienced rapid economic growth as a member of the World Trade Organization.
One question that this study is unable to address concerns the mechanism behind the documented large share of retained earnings in Chinese listed companies. Given the scope of this study, it is suspected that the answer to this question is quite extensive and complex. What can be established is that princely-type political connections appear valuable, but it is not clear why PLGs store retained earnings.
We hope that this study can trigger further analysis to investigate the source of our documented effects and better explain the value effects to external investors. 3These results are still informative as they support the argument that Chinese PLGs tend to pay lower dividends on average.
APPENDIX
Variable Definition
- Selling expense to total assets (SEXP ) Unconnected Connected
- Total current assets
- Total current liabilities
- share capital
Corporate governance and dividend policy: A comparison of Chinese firms listed in Hong Kong and on the mainland. OCTA is the ratio of cash received from sales of goods divided by total assets. NOC is the ratio of net cash flow from operating activities divided by total assets.
This table presents the results of the OLS regression of the effects of political connections on the distribution of earnings. Time trends of operating performance measures of principal-linked firms (PLG) and unrelated firms.
