Politically Motivated Corporate Decisions As Tournament Participation/Inclusion Games

Two conflicting hypotheses assess the effect of political tournaments on corporate decisions: 1) uncertainty regarding outcomes reduces economic activity, and 2) agency-driven incentives increase economic activity. Further assertions suggest that under democratic elections the former hypothesis prevails, and under autocratic promotions the latter does. Indeed, Julio and Yook (2012) found that democratic elections are associated with reductions in corporate investments. In this paper, we investigate the effect of Chinese political cycles on Chinese corporate decisions. Every five years, 31 mainland China province heads compete for promotions to the national congress by demonstrating high economic performance. We study 17,534 yearly firm observations from 2000-2013. Controlling for economic conditions, we find that average investment rates are 7% higher two years before national promotions. We further examine promotion effects on tax revenues and find that firms, on average, pay 4.1% more taxes in the year leading up to national promotions. We study jointly employment, wages, cash holdings, debt, stock returns, and stock volatility using simultaneous equations and find pervasive effects of impending political promotion cycles. Finally, studying firms dual-listed in China’s mainland and Hong Kong, we find that price discrepancies increase prior to promotion cycles. We demonstrate cyclicality in corporate decision-making synchronized with political promotion cycles. Our evidence is consistent with political leaders exerting power over firms when competing for promotions. We consider this study especially unique and interesting because it captures corporate decisions mostly induced by political motivation and not directly related to corporate stakeholders. In contrast, under democratic regimes, it is hard to separate the extent to which corporate decisions, including political and charity contributions, are equilibrium optimal ones rather than constrained ones.