Do Political Connections of Independent Directors Increase the Corporate Risk-Taking Level?

Zhou Zejiang; Ma Jing; Liu Zhongyan

doi:doi:10.16538/j.cnki.jfe.2018.08.011

Summary

Independent directors are characterized by " native” risk-aversion effects during their work, but it doesn’t attract enough academic attention on how characteristics of independent directors affect corporate risk-taking in China for a long time. As we know, political connections among independent directors are common phenomena in China’s capital market, and it has exerted widespread and far-reaching impacts on the performance of independent directors.　　Based on the above, the article chooses political connections in transitional economy as a breakpoint, and uses A-share listed companies between 2007 and 2014 as samples to examine whether political connections of independent directors can make corporations take more risks. In particular, we measure political connections based on whether independent directors have the government background or act as NPC/CPC representatives and CPPCC members, and use accounting earnings (cash earnings) adjusted by the industry-year average as the proxy variable of the corporate risk-taking level. 　　The empirical evidence shows that political connections of independent directors enhance risk-taking significantly. It indicates that when the number of independent directors with political connections increases, the corporate risk-taking level rises accordingly. Moreover, there is a moderating effect of demographic characteristics on the relation, which shows that when the education background becomes better and the female ratio increases, the enhancing degree of the corporate risk-taking level arising from political connections decreases, but the age doesn’t have significant impacts. Additional tests reveal that corporate risk-taking plays a partial mediation role on the relation between political connections of independent directors and operation performance. All of these mean that political connections can weaken risk aversion effects of independent directors; moreover, the relation is limited by demographic characteristics like the education background and the gender.　　Compared with the previous literature, the theoretical contributions of this article contain the following three points. First, the existing literature mainly analyzes the role of senior executives or CEOs in corporate risk-taking (Pathan, 2009; Yu, et al., 2013), and ignores independent directors. In fact, independent directors are more risk-sensitive in the decision-making process (Yu, et al., 2010), thus this article enriches the theory of corporate risk-taking. Second, the scope of political connections is limited to specific groups such as the CEO, the chairman, the board member, etc. (Fan, et al., 2007; Yu and Pan, 2008). The main body of political connections is extended to the independent director level in this article, which will help us to learn how the influence of political connections changes with the main body change. Finally, the article provides direct evidence on risk aversion of independent directors, which are quite different from indirect evidence in existing empirical literature.　　Above all, the article incorporates political connections and demographic characteristics into the analysis framework of how independent directors work, and is helpful for the comprehension on functions of independent directors in China’s context. According to the conclusion, we should pay attention to these following points in future: (1) Whether selecting independent directors with political connections depends on the demand of corporate development, for example, enterprises in quick development need a higher risk-taking level, so hiring independent directors with political connections will reduce frictions when communicating with top management. (2) Enterprises should take demographic characteristics into consideration when selecting independent directors. Based on the above discovery, if there is a need to decrease corporate risk-taking, enterprises can hire independent directors with higher education and female gender. (3) Independent directors don’t always play a " vase” role. Although listed companies are required to limit the proportion of independent directors to 1/3, there are still disparities among independent directors of the same proportion. Therefore, we should consider the tenure characteristics in the employment process of independent directors.