The Dark Side and Bright Side of Political Connectedness: Evidence from Corrupt Firms

Abstract

Corruption is a pervasive, destructive, and persistent problem in corporate world. The 2018 Report to the Nations on Occupational Fraud and Abuse finds the loss caused by fraud was more than US$7.1 billion. Although there is no magic and instant recipe in dealing with corruption, there has been a global call for developing solutions to fight the corruption problem. In the past decade, maintaining good corporate governance is one of the recommended answers to address the corruption problem by reforming the business climate to be more transparent and providing more investor protection. This study examines the drivers of corruption from the legal, political, and cultural perspectives as well as the effectiveness of several governance mechanisms in combating corruption. In particular, we focus on the impacts of political connectedness as the cause and solution of the corruption problem. This research highlights the growing trend of appointing politically-connected directors as corporate political strategy. The resource dependence theory suggests the importance of board political capital as it provides the connected firms with preferential access to different benefits. We formulate theory on both the dark side and bright side of political connectedness that have distinct impacts on the incidence of regulatory enforcements. First, we hypothesize the politically-connected firms are more likely to face regulatory sanctions than their unconnected peers. Next, we posit the politician-directors can use their central political connectedness to buffer the disciplinary pressure from the regulatory body. Third, based on the propositions of ethicality, risk aversion, and diversity, we advance the view that female politician-directors are effective monitors for preventing their connected firms from committing corruption. Finally, we argue that the formal system of government supervision and the informal institutional arrangement of subnational culture can also be governance measures to fight corruption problem. Using 762 pairs of corrupt and non-corrupt Chinese firms over 2010-2013, we find empirical support for our arguments. The prevalence of corrupt privately-owned enterprises provides evidence supporting the view for the corruption of the rich (power-money deals). This study sheds light on how the strength of the political ties and gender matter in board political capital. Our finding that the monitoring carried out by female politician-directors constitutes an effective board governance mechanism provides practical implications for board gender diversity policy and corporate political strategy. In addition, government supervision and subnational culture of socialism and Confucianism are, to some extent, effective governance mechanisms for determining the likelihood of corrupt activity.