Red Capitalists: Political Connections and Firm Performance in China

Uncertainty in the policy making process creates substantial transaction costs for firms (Williamson, 1991; Henisz andZelner, 2004). Consequently, business organisations engage in political behaviour to internalise these costs and influence the policy process in ways favourable to them. The current paper is concerned with a particular form of political strategy adopted by firms in China. A significant number of private-owned enterprises adopt the so-called ‘‘red hat’’ strategy by seeking political affiliation with the Communist Party andvariousgovernmental entities. Somescholars see this strategyasameansof circumventing problems associated with the lack of secure property rights and institutional discrimination, such as the lending bias of China’s state-dominatedbanking systemagainst indigenous entrepreneurs (Li et al., 1999;Huang, 2003), heavy government regulations and extralegal fees (Johnson et al., 2000; Guriev, 2004). This view is consistent with the ‘‘helping hand’’ theory of government-business relationship (Che andQian, 1998).However, theory also predicts that government bureaucrats tend to be more interested in rentseeking, extraction and political objectives rather than corporate efficiency and maximising firm value (e.g. Shleifer andVishny, 1998; Rosa and Pérard, 2010). Given that politics and business have always been interrelated, it is perhaps surprising to observe that there is a paucity of work analysing the corporate performance implications of political connections. The few studies in this area include Fisman’s (2001) estimation of the value of political affiliations to firms in Indonesia and the analysis of Leuz and Oberholzer-Gee (2006) on the financing strategy of politically connected Indonesian firms. For Malaysia, Johnson and Mitton (2003) uncover a strong positive correlation between stock market performance and political connections in Malaysia in the KYKLOS, Vol. 63 – November 2010 – No. 4, 530–545