Political connections and corporate overinvestment: evidence from China

Abstract

Purpose – Using panel data for the period 2004-2010, this study shows that political connections have a significant positive effect on corporate overinvestment in China while their interaction with related-party transactions has a negative effect. Results also indicate that state-owned enterprises (SOEs) controlled by the Chinese central government tend to have greater overinvestment than non-SOEs. However, their interaction with related-party transactions has an opposite effect on overinvestment, lending support to the conjecture that firm ownership structure plays a significant role in corporate overinvestment decisions. The paper aims to discuss these issues. Design/methodology/approach – Panel data analysis and regression. Findings – This study shows that political connections have a significant positive effect on corporate overinvestment in China while their interaction with related-party transactions has a negative effect. Results also indicate that SOEs controlled by the Chinese central government tend to have greater overinvestment than non-SOEs. Research limitations/implications – The research shows some Chinese firms' behavior that indicates expropriation of minority stockholders. Policymakers should be aware of this issue as overinvestment is not good for the economy as a while. The limitation of the study is based on six-year data. Practical implications – Stockholders should monitor the firms to mitigate the overinvestment problems in Chinese firms. Originality/value – This is the first paper to examine the overinvestment issue along with related-party transactions and political connections.