Political power differential and forced CEO turnover: Evidence from Chinese non‐state‐owned enterprises

Abstract

AbstractIn China, the prevalence of strong political connections among a significant number of boards of directors and CEOs highlights the importance of cultivating such relationships. This is particularly relevant when considering the Chinese political system where officers holding higher political ranks wield dominant, or even absolute, power in decision‐making. Our findings reveal that the political power differential (PPD) between a board of directors and its CEO plays a pivotal role in mitigating CEO entrenchment associated with political power. Specifically, when directors possess more political power than their CEOs, they can effectively fulfil their disciplinary role, leading to the dismissal of underperforming CEOs. Our study substantiates a significantly positive relationship between PPD and the probability of a forced CEO turnover, as well as the sensitivity of CEO turnover to performance. Notably, as PPD increases by one standard deviation from its mean level, we observe an approximate 30% increase in CEO turnover‐performance sensitivity. These findings confirm a higher likelihood of replacing underperforming CEOs in firms with a politically powerful board. Our results also highlight that a higher proportion of either independent or female directors alone does not guarantee effective monitoring. The key lies in ensuring that these directors possess stronger political power than the CEO.