Investor perceptions of the benefits of political connections

Abstract

Purpose– The purpose of this paper is to investigate how foreign and domestic investors differ in their beliefs about the relative merits of a firm's political connections.Design/methodology/approach– These differences are employed to explain cross-sectional variation in the previously documented premium in A-share prices relative to otherwise equivalent foreign currency denominated B-shares for Chinese firms.Findings– Chinese domestic individual investors were excluded from owning B-shares of Chinese firms prior to February 20, 2001. The authors find that firms with more political connections have higher premiums and a smaller reduction in premiums associated with this event.Research limitations/implications– This is consistent with domestic block holders deriving additional benefits from politically connected firms.Practical implications– The findings also have important policy implications by showing that government can have a strong effect on the economy even without applying macro-policy tools.Social implications– Government ownership in listed companies can result in discrepancies among classes of investors with respect to their valuations. Furthermore, the prohibition of short sales prevents arbitrage from correcting this bias, and eventually the role of the market in allocating resources efficiently is undermined.Originality/value– The authors investigate the role of political connections as implied by the proportion of state ownership in explaining the A-share premium. Unlike previous studies that associate state ownership with political risk, the paper relates state ownership to political connections that are particularly beneficial to domestic large block shareholders. This interpretation is consistent with the findings and with previous literature on state ownership and political connections of Chinese firms.