Scandinavian Working Papers in Economics

Working Paper Series,
Stockholm School of Economics, China Economic Research Center

No 2011-18: Escaping Political Extraction: Political Participation, Institutions, and Cash Holdings in China

Xunan Feng and Anders C. Johansson ()
Additional contact information
Xunan Feng: Shanghai Jiaotong University
Anders C. Johansson: China Economic Research Center, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: We study the effects of political participation on holdings of liquid assets in a transition economy. Previous research has shown that the risk of political extraction by politicians and bureaucrats in countries with weak institutions has an adverse effect on holdings of liquid assets. We propose that political participation by private entrepreneurs can function as a means to alleviate some of that risk. Our empirical results indicate that political participation is positively related to cash holdings in China, especially in regions with weak institutions proxied by lower GDP per capita, lower marketization levels, and weaker property protection. Cash holdings have a negative effect on firm value as measured by the market-to-book ratio. However, political participation, the combined effect of cash holdings and political participation, as well as the combined effect of cash holdings, political participation, and institutions are all positively associated with firm value. Political participation thus results in an improved ability for firms that function in an environment fraught with the risk of political extraction to increase their holdings of liquid assets as well as a related positive effect on firm value.

Keywords: Political participation; Private entrepreneurs; Cash holdings; Political extraction; China

JEL-codes: G31; G32; G34; P48

41 pages, March 15, 2011

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