The Value of Politically Connected Director: A Natural Experiment in China

Abstract

This study examines the stock price response to the 2013 regulation (Document 18) in China which requires independent directors with political connections to resign from the board of directors of publicly listed firms. We document a significant positive price response in the window surrounding the promulgation date and the response is also of important economic magnitude. The finding suggests that the market views the costs of hiring politically connected directors outweighing the associated benefits. Consistent with this view, politically connected directors display shirking behavior as evidenced by poor board meeting attendance. Further investigations show that the value decreasing of politically connected directors is mainly apparent within regulated industry and varies with earnings management practices. Interestingly, the market views politically connected directors favorably if firms have significant business transactions with the government.

Keywords: political connection, independent director, China, exogenous shock, event study

JEL Classification: M14