Knut Wicksell Working Paper Series,
Lund University, Knut Wicksell Centre for Financial Studies

Abstract: I measure the value of political connections through their liquidity effect on privately controlled firms and state-owned enterprises (SOEs) in China’s stock market over the period of 2003 to 2012. State participation among the top ten shareholders is used as a criterion for classifying a firm as “politically connected”. Using this criterion, I find that politically connected firms are associated with higher liquidity, which is manifested by tighter spreads, higher quoted depths, greater trading activity, lower adverse selection spread components and a smaller price impact. I further examine the effects of three dimensions of political connections on liquidity: political network, hierarchy and intervention. First, I determine that a greater political network results in greater liquidity for both state-owned and privately controlled firms. Second, SOEs that are centrally controlled possess higher liquidity than those that are locally controlled. Third, greater political intervention arising from direct government control impedes the positive impact of political connections on liquidity.

Keywords: Political connections; Firm liquidity; Corporate governance; Firm value; Information asymmetries; Trading activity

JEL-codes: C23; G12; G18; G32

50 pages, December 1, 2014

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