Political connections of independent directors and firm internationalization: An empirical study of Chinese listed firms

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Abstract

Using Chinese A-share listed sample firms, we find a significantly positive association between independent directors' political connections and firm internationalization. This association is more pronounced in firms in western regions of China compared to that in firms in eastern regions of China. We also find that the Chinese government's recent adoption of anti-corruption practices increases the probability of firm internationalization. However, independent directors' political connection would promote firm internationalization only in firms where the top manager does not has political connections or in non-state-owned firms, indicating that top managers' political connections may play an inhibitory effort on firm internationalization, and there is to some extent a substitution effect between state ownership and independent directors' political connections in promoting firm internationalization.

Introduction

Given the growing and deepening development of globalization, expanding international markets has become an important strategy for firms in emerging markets to pursue value growth (Lu et al., 2010). With the implementation of The Reform and Opening up Policy for over thirty years, the blooming of the world economy, and the Chinese government's strategic internationalization of The Belt and Road Initiative in recent years, more and more Chinese firms are accelerating their pace in opening up international markets. However, due to the complex, competitive, and ever-changing international market environment, the barriers to entering international markets, and the substantial administrative costs of international mergers and acquisitions, Chinese firms face great challenges in the process of internationalization. One of the major challenges is determining how to seek and utilize external resources actively to promote international business (Bruton et al., 2007; Elango and Pattnaik, 2007; Luo, 2003). As important social capital, political connections help Chinese firms acquire the necessary resources for internationalization, avoid the political and financial risks that are endemic to the internationalization process, and reduce the administrative costs of international mergers and acquisitions. However, to the best of our knowledge, empirical research on the association between political connections and firm internationalization is quite limited.

Political connections exist around the world (Goldman et al., 2013) and are extremely important in developing markets with strong government regulations (Yu et al., 2015). Across many industries, firms' success in political connections is as important as their success in product or capital markets. Therefore, political connections are considered to be a critical factor when making strategic decisions (Baron, 2005). Prior research has documented that political connections have significant impacts on a firm's preferential tax policy, its judicial implementation, its information disclosure, and its access to debt financing and governmental subsidies (Adhikari et al., 2006; Chaney et al., 2011; Claessens et al., 2008; Correia, 2014; Cull and Xu, 2005; Dinc, 2005; Faccio et al., 2006; Fan et al., 2007; Houston et al., 2014; Johnson and Mitton, 2003). Recent research has found that political connections also help firms expand international business, explore more opportunities for international growth, and acquire the resources for international operations while reducing the associated risks (Liesch and Knight, 1999; Lu et al., 2010; Peng et al., 2008; Ruzzier et al., 2006). However, research on political connections has not kept pace with firms' political practices (Hillman, 2005). For example, Zhang and Mauck (2018) find that political connections are only value-enhancing under some, but not all, circumstances. The existing research has primarily focused on the political connections of top managers (i.e., presidents, CEOs, and other members of the board of directors), and little research has examined the political connections of independent directors (Huang and Wei, 2016; Wang, 2015).

Top managers enjoy the right to formulate strategic decisions and implement strategic policies, whereas independent directors play an important advisory role and help companies handle their relationships with the government. Independent directors also help protect investors' interests and alleviate agency problems by virtue of their economic independence and reputation mechanism. When independent directors have political connections, their supervisory governance functions may be significantly weakened, and the role of independent directors is likely to be shifted from a supervisory function to advisory and/or coordinating functions. Firms recruit independent directors with political connections in order to take advantage of their exclusive political capital when dealing with practical problems, such as government intervention, industry access, and credit support, rather than to strengthen supervision. Prior literature has documented that independent directors who also serve as governmental officials can better assist firms in acquiring resources (Du et al., 2014; Huang and Wei, 2016; Lee et al., 1999; Wang, 2015; Wang et al., 2017; Wei et al., 2007; Yu et al., 2015).

This study addresses three complementary research questions in the context of China. First, is firm internationalization associated with the political connections of independent directors? Second, does this association vary for western and eastern regions of China due to the differences in institutional environment and marketization? Third, does this association vary for the pre-anti-corruption and post-anti-corruption periods?

The association between the political connections of independent directors and firm internationalization merits study for three reasons. First, in the process of business internationalization, independent directors with political connections may use their exclusive political resources to help firms solve problems such as restrictions from the institutional environment and inadequate knowledge and experience. Second, the differences in institutional environment between western and eastern regions of China and the shock of the long-term sustained anti-corruption launched by the Chinese government might have different impacts on the association between political connections of independent directors and firm internationalization. Examining the differences will bring important implications to emerging markets with different institutional environments and rapid institutional changes. Third, the selection and recruitment of independent directors is a two-way process between firms and individuals. Compared to those who have no political connections, independent directors with political connections undoubtedly enjoy more resources and opportunities due to their unique access to exclusive political capital. Therefore, independent directors with political connections may be more inclined to choose larger firms that have easy access to the resources controlled by the government and thus fewer financing constraints. For these reasons, endogeneity could be an issue that has been overlooked in prior literature when examining the performance of independent directors.

Currently, the Chinese government strongly encourages the implementation of internationalization. Thus, it is important to explore the factors that influence firm internationalization. Across its vast territory and large population, China shows great variation in the levels of economic development and marketization. Firms in western regions of China have the inherent disadvantages of environmental obstruction, poor communication with the outside world, a lack of cost-efficient shipping, underdeveloped property rights protection systems, serious financing constraints, backward development of intermediary organizations, and weak legal enforcement. Therefore, the advisory and coordination functions of independent directors with political connections may play a more significant role in firm internationalization in China's western regions than in its eastern regions.

In addition, China's institutional environment has undergone major changes in recent years. China is ruled monopolistically by one single political party, the Communist Party of China (hereafter, the CPC). On December 4, 2012, the Political Bureau of the CPC Central Committee passed the Provisions of the Political Bureau of the CPC Central Committee on Improving Working Style and Close Contact with the Masses (hereafter, The Eight Rules). Since then, China has been tirelessly fighting against corruption for a clean government. On October 19, 2013, the Central Organization Department of the CPC Central Committee released the document Advice on Further Standardizing the Issue of Party and Government Leading Cadres Taking Part-time or Full-time Jobs in Firms” (hereafter, The No.18 Document). These documents impose strict and specific restrictions on party and government leading cadres who take part-time or full-time jobs in terms of the types of jobs they can take and the durations, numbers, and age limits for different job positions. Due to these policies, many officials who had worked as part-time independent directors resigned from their independent director positions. To some extent, these anti-corruption efforts have prevented government officials from rent seeking by increasing the costs and risks for government officials seeking privileges from firms. In 2013, the Chinese state leaders proposed The Belt and Road Initiative, explicitly expressing the government's support for Chinese firms to go international. With all these environmental changes, the association between independent directors' political connections and firm internationalization remains an open empirical question.

We find that independent directors with political connections have a significantly positive association with firm internationalization and that the association is more pronounced in firms in western regions of China compared to those in eastern regions. Owing to The No.18 Document, the proportion of independent directors that have political connections has decreased. We find that after the Chinese government's adoption of anti-corruption measures, not only the firm internationalization was promoted, but also the relationship between firm internationalization and the political connection of independent directors became more significant.

In additional analyses, we further examine how top managers' political connections affect the relationship between independent directors' political connections and firm internationalization. Compared with independent directors, top managers tend to have more incentives to acquire resources to obtain large government orders on the domestic markets through their “strong” political connections. The greater monopoly power on the domestic market may inhibit firm internationalization to a certain extent. In such a case, the effect of independent directors' political connections on promoting firm internationalization may be negligible. Our results confirm that independent directors' political connections would promote firm internationalization only when top managers have no political connections.

This study contributes to the literature in several ways. First, to the best of our knowledge, this is the first paper on the association between the political connections of independent directors and firm internationalization on more spectrums. Specifically, we conduct several robustness tests and consider the potential impacts of top managers' political connections and state ownership. It extends the literature in related areas such as political connections, functional effects of independent directors, and firm internationalization. Second, we examine the impact of regional and institutional environment changes on the association between political connections of independent directors and firm internationalization. Third, our findings provide empirical evidence that can be exploited to further improve China's institutional construction and its promotion of the internationalization of Chinese listed firms, and they also provide a reference for the internationalization of firms from other emerging markets. Finally, to enhance the reliability of our empirical results, we adopt Heckman's two-stage model to address the endogeneity problems that are prevalent in prior research on independent directors.

The rest of the paper proceeds as follows. Section 2 summarizes the prior literature and develops our hypotheses. Section 3 describes our research design. Section 4 presents our empirical results, and Section 5 concludes.

Section snippets

Political connections of independent directors and firm internationalization

As a developing and transitional economy, China is not only open to global competitors, but also lacks of clarity in terms of property rights protection and poor industry regulation (Nee, 1992). In such a context, connections provide an alternative mechanism to the formal system for ensuring the smooth conduct of commercial transactions (Allen et al., 2005; Yang, 2011). Moreover, political connections are more beneficial in countries with more interventional government regulations and weaker

Sample selection

Our sample period is during year 2010 and 2017. We started the sample selection with the firm-year observations from all Chinese A-share companies listed prior to year 2010 and conducted the following screening procedures: (1) financial firms are excluded due to the different nature of their financial reports, (2) firms with independent directors of ambiguous background disclosure are excluded, (3) firms with no or unavailable regional disclosure of domestic or overseas sales revenue are

Descriptive statistics

Table 1 reports the proportion of independent directors with political connections among all independent directors. The proportion of independent directors with political connections among all independent directors ranges from 28.86% to 43.04% and has an average value of 37.41%, suggesting that approximately 37% of the independent directors in Chinese listed companies have political connections. Besides, affected by The No.18 Document after the anti-corruption, the proportion of independent

Conclusion

Internationalization becomes a critical strategy for firms in emerging markets to achieve growth and attracts more scholars' attention around the world (Lu et al., 2010; Manolova et al., 2010). Chinese firms may use social capital to obtain the resources for international operations, reduce the risk of international operations, and explore more international growth opportunities (Liesch and Knight, 1999; Lu et al., 2010; Peng et al., 2008; Ruzzier et al., 2006). Prior studies on firm

Acknowledgments

The authors truly appreciate the editor and referee for the helpful comments about the paper, and the National Natural Science Foundation of China (Grant/Award Numbers: 71772123) and the Science Foundation of Ministry of Education of China (Grant/Award Number: 15YJA630078) for financial support.

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