The effect of political influence on corporate valuation: Evidence from party-building reform in China

Abstract

The party-building reform in China aims to strengthen the party-state control of firms by formalizing the Chinese Communist Party’s (CCP) role in corporate charters. We employ the reform as an exogenous shock to examine the effect of political influence on corporate valuation in the state-dominated economy. We first develop a hazard model of firms’ responses to the reform and use the predicted hazard rate as a proxy for a firm’s ex ante political influence. We find a positive correlation between firm valuation changes and the predicted hazard rate in the events of party-building reform announcements and a consistent long-term valuation effect based on the difference-in-differences analyses. We also find that the market reacts negatively when firms elect to adopt charter provisions that allow the CCP to control their personnel decisions. Together, our results are consistent with the hypothesis that the effect of party-building reform on a firm’s valuation depends on the trade-off between the benefits from the increased state capture and the costs of state influence in firm governance and that the enhanced political control costs are mitigated for firms with stronger existing political ties. This paper contributes to the literature by introducing a novel and integrated approach to measuring political influence that goes beyond the traditional state ownership measurement and by identifying ex ante political influence as an important factor in corporate valuation.