Do Politically Connected Directors Affect Accounting Quality? Evidence from a Natural Experiment

• In Event: Political Connections and Lobbying

Abstract

We examine the impact of politically connected directors on accounting quality using a natural experiment in China. In October 2013, “Rule 18” was issued to forbid government and party officials, who were in position or retired in the past three years, from serving as directors for publicly listed firms. The regulation, which is an important component of China’s anti-corruption campaign, led a large number of politically connected directors to involuntarily resign as directors, and as such, it effectively weakened or even cut off the previously established political connections of these firms. Our empirical analyses employ a difference-in-differences research design with firm fixed effects to examine the pre- and post- period accounting quality around the enactment of Rule 18. We find that, compared to propensity-score-matched control firms, the accounting quality of firms with politically connected directors increases after Rule 18, and that the effect is stronger for non-SOE firms than for SOE firms. We further examine the channels through which politically connected directors affect accounting quality. The evidence suggests that connected firms have better access to preferential financing and lax regulation through the political connections of their directors, and this reduces firms’ incentives to provide transparent information. Our results establish a causal effect of politically connected directors on accounting quality.

Authors

• Ole-Kristian Hope, University of Toronto - Rotman School of Management

• Heng Yue, Singapore Management University

• Qinlin Zhong, Peking University - Guanghua School of Management