Politically Connected Boards, Value or Cost: Evidence from a Natural Experiment in China

Abstract

This study investigates the net effect of a politically connected board on a firm. Using a quasi-natural experiment in China -- a regulatory change to forbid bureaucrats sitting on the board of listed firms -- we address the causality by testing the market reaction. The firms with politically connected directors who are affected by the regulatory change show on average a significantly positive cumulative abnormal return. The result is robust for various model settings and for a matched sample using the propensity score methodology. Additionally, the announcement effect of a politically connected director resignation is significantly positive, and significantly higher than that of a non-connected director resignation. Overall, our results suggest that the agency cost effect of a politically connected director dominates the value effect.

Keywords: Political Connection; Outside Director; Regulatory Change; Resignations

JEL Classification: G31,G32