Do CEO Connections to the Chinese Politburo Pay Off and How?

Abstract

ABSTRACTResearch Question/IssueThis study investigates the effect of connections to the Politburo, the top 25 members of the Chinese Communist Party (CCP), on CEO compensation, pay‐for‐performance sensitivity, and turnover decisions using a comprehensive dataset of 3764 Chinese listed firms from 2007 to 2019.Research Findings/InsightsOur findings reveal that CEOs of privately owned listed firms who have connections to the Politburo via shared educational backgrounds receive significantly higher compensation (up to 20% more). However, such connections do not significantly affect CEO compensation in state‐owned enterprises (SOEs). CEOs who have connections to the Politburo also exhibit lower turnover rates, and their compensation is less sensitive to performance outcomes. Our measure of connections excludes reverse causality, as we leverage an exogenous shock—the promotion to the Politburo of an individual with whom the CEO is already connected—to investigate the gain associated with a political connection in the absence of CEO turnover in private firms. This event allows us to observe that CEO pay increases significantly in such cases. We also find that elite connections serve as a mechanism for resource allocation, as politically connected CEOs in private firms benefit from higher subsidies and lower tax rates, and politically connected CEOs in SOEs benefit by being appointed to larger SOEs. Additionally, we find that the positive relationship between CEO pay and elite connections is even stronger when the connection is stronger but is negative when the CEO is a CCP member.Theoretical/Academic ImplicationsThis study enriches the literature on political connections by introducing a novel proxy for elite connections based on past educational ties to members of the political elite. It disentangles the influence of personal educational connections to the political elite from that of a more generic political membership of the CCP, offering a clearer understanding of their distinct impacts.Practitioner/Policy ImplicationsOur study underscores the necessity of differentiating between private and SOEs in China due to their distinct characteristics and goals. Furthermore, it highlights the critical role of elite political connections in emerging economies such as China in resource allocation, labor market dynamics, and corporate governance.