Research Insights

In China, it’s still who you know

By Dr. Fang ZHANG

Despite years of reforms, the Chinese government retains substantial influence over the corporate sector, providing a clear incentive for firms to develop political ties. Yet, as firms increasingly rely on market mechanisms to carry their business, they also benefit from maintaining political connections. Which of these centrifugal forces matters the most? Dr. Zhang answers this question by analysing 236 Chinese corporate scandals, categorising them as political, market, or mixed. She demonstrates that political scandals and mixed scandals, by signalling the loss of a firm’ political ties, are associated with worse stock market returns than mere impact in market credibility. This conclusion is supported by a range of other metrics. Factors like a steeper deterioration in operating performance, the recall of loans extended by state-owned banks, the replacement of tainted directors by individuals deemed to have a better political standing, and a higher recovery in the share prices of firms that managed to repair broken political networks all point to the importance of political connections. Even today, China’s economy still remains more politically-driven than market-based.

Reference:

Mingyi Hung, T. J. Wong, Fang Zhang. The value of political ties versus market credibility: evidence from corporate scandals in China*. Contemporary Accounting Research Vol. 32 No. 4 (Winter 2015) pp. 1641-1675.