The agency cost of political connections: Evidence from China's File 18

Abstract We examine the influence of political connections on the agency conflicts between controlling shareholders and minority shareholders using the exogenous setting of File 18, which was enforced by China's central government. File 18 restricts officials from taking up positions in corporations. We find that tunneling by the controlling shareholders of politically connected firms has declined significantly since the enforcement of File 18. The decline in tunneling is more pronounced for firms operating in more corrupt regions, and is more significant for firms that are less creditworthy or that have greater financing needs. Our findings are consistent with the fact that political connections motivate tunneling.