Does the cutoff of “red capital” raise a red flag? Political connections and stock price crash risk

Abstract

Using a Chinese exogenous regulatory setting that forbids political officials from sitting on boards, we investigate whether disruption to political connections induced by independent director’s forced resignation increases the firm’s stock price crash risk. The results show that firms announcing resignations of politically-connected independent directors after the regulation experience a significant increase in crash risk, suggesting that disruption to political connections intensifies managers’ bad-news hoarding behavior and makes firms more crash-prone. We further find that the negative impact of disrupted political connections on crash risk is less pronounced in state-owned enterprises (SOEs) than that in non-state-owned enterprises (non-SOEs). Moreover, the association is more salient when the resigned director has a geographic and industrial working background overlapping with the firm’s operation. Our findings are consistent with the notion that heightened resource acquisition pressure caused by disruption to political networks increases stock price crash risk.