Political Connection, Financing Frictions, and Corporate Investment: Evidence from Chinese Listed Family Firms

Using a sample of Chinese family firms from 2000 to 2007, we investigate whether the political connection of the family firms will help them to reduce the frictions they face in external financing in a relationship-based economy. We find that political connectedness of family firms could reduce their investment-cash flow sensitivity. More interestingly, this political connectedness effect exists only in financially constrained family firms. However, from governance dimension, we cannot find any significant variation of the political connection effect on the sensitivity of investment to cash flow. We argue that these evidences are consistent with the firm’s underinvestment arising from the asymmetric information problems, and are inconsistent with the firm’s overinvestment arising from the free-cash-flow problems. Our paper corroborates the previous evidence that the firms’ political connectedness could favor them by exploring another channel through which political connection could add value to firms, i.e., increasing the investment efficiency by reducing the cost of external financing in a relationship-based economy. However, the political connection benefits vary with firm’s financial situations. Moreover, we also find that the underinvestment rather than overinvestment is a more important distortion in Chinese family firms.