Local official turnover, ownership, and firm cash holdings: Insights from an emerging market

AuthorXiaoran Ni
Date01 September 2019
Published date01 September 2019
DOIhttp://doi.org/10.1111/eufm.12194
DOI: 10.1111/eufm.12194
ORIGINAL ARTICLE
Local official turnover, ownership, and firm cash
holdings: Insights from an emerging market
Xiaoran Ni
Department of Finance, School of
Economics and Wang Yanan Institute for
Studies in Economics (WISE), Xiamen
University, 361005, China
Email: nxr@xmu.edu.cn
Abstract
Using a hand-collected dataset of city-level local official
turnover in China, I find that average cash holdings of listed
firms decrease significantly upon turnover of city heads, and
this effect concentrates in privately owned enterprises. Such
effects are more pronounced in firms located in cities with
lower government quality. I also find that local official
turnover leads to decreases in equity issuance for privately
owned enterprises but not for state-owned enterprises,
which largely explains our primary findings. Overall, this
paper reveals that the cash policy of privately owned
enterprises is sensitive to local official turnover in an
emerging market.
KEYWORDS
cash holdings, emerging market, local official turnover, ownership
structure
JEL CLASSIFICATION
G18, G32, G38
I thank John Doukas (the Editor), two anonymous referees, Chongen Bai, Weixing Cai, Hui Dong, Xiaosheng Ju, Yue Li,
Shangkun Liang, Ajid Ur Rehman, Guoman She, Sandy Suardi, K. C. John Wei, Sirui Yin, Xiaofeng Zhao, and participants
at the 2016 Frontiers of Business Research in China International Symposium (Beijing), 2016 Chinese Young Economists
Conference (Beijing), 2016 China Finance Review International Conference (Shanghai), 2016 Chinese Finance Annual
Meeting (Dalian), 2017 European Financial Management Symposium (Xiamen), 2017 China Accounting and Finance
Conference (Beijing), and seminar participants at Guangdong University of Finance and Economics for their helpful
comments. I especially thank David Ji for his efforts on earlier versions of the paper. All errors are my own.
Eur Financ Manag. 2018;134. wileyonlinelibrary.com/journal/eufm © 2018 John Wiley & Sons, Ltd.
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INTRODUCTION
Cash is of vital importance to firms. As a method to ease financial frictions, cash holdings determine
whether businesses can take advantage of investment opportunities. However, cash is vulnerable to
expropriation by entrenched managers and local officials, especially in economies with powerful
governments and less developed legal systems (Caprio, Faccio, & McConnell, 2013; Chen, Li, Xiao, &
Zou, 2014; Feng & Johansson, 2014; Stulz, 2005). In such economies, turnover of government officials
can significantly affect government policies (Mikesell, 1978; Rogoff & Sibert, 1988). Although a vast
number of studies investigate the economic impact of turnover of government officials, they focus
primarily on the uncertainty of election outcomes (e.g., Atanassov, Julio, & Leng, 2015; Julio & Yook,
2012). It remains largely unexplored whether government official turnover can affect firm behavior in
ways other than creating uncertainty prior to elections. To fill this gap, I utilize a hand-collected dataset
from China and investigate the effect of local official turnover on firm cash holdings.
I take advantage of frequent city-level local official turnover in China, where a higher-level
authority changes local leaders partially based on their economic performance (Cull, Xu, Yang, Zhou,
& Zhu, 2017; Xu, 2011). At the city level, many officials serve for very short periods of time.
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The
inherent short-term horizon of this multilayer hierarchy motivates newly appointed officials to make a
rapid impact to be selected for promotion (Gao, Long, & Xu, 2016). Since it takes time to transform
investment projects into gross domestic product (GDP) growth, such officials tend to initiate image
projects immediately after assuming office in the radical manner of new brooms sweep cleanto
increase their likelihood of promotion (Cao, Julio, Leng, & Zhou, 2015; Du, Lu, & Tao, 2015).
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Theoretically, the effect of local official turnover on firm cash holdings is ambiguous. It is possible
that turnover of local officials may reduce cash holdings. I consider two views regarding the role of
local governments: the grabbing hand view and the helping hand view. The former view conjectures
that newly appointed officials with promotion incentives may expropriate firms. Local officials may
enlist firms, especially those with a significant amount of cash, to provide funding for public projects,
which can be unprofitable for the firms but helpful to local governments (Du et al., 2015).
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After the
original official leaves, firms lose their established political connections and become vulnerable to
expropriation (Feng & Johansson, 2014). Therefore, they take action to minimize such risk when the
cost of doing so is relatively small (Li, Maydew, Willis, & Xu, 2014). Not only can actual political
expropriation have an effect, but the prospect of political expropriation can also cause firms to
strategically shelter their cash (Caprio et al., 2013; Smith, 2016). Therefore, the grabbing hand view
predicts that newly appointed officials may decrease firm cash holdings.
The helping hand view suggests that newly appointed officials with promotion incentives may
support firms. Local governments can assist firms in various ways, such as providing subsidies (Lim,
Wang, & Zeng, 2018) and information (Cull et al., 2017), helping them secure loans from debtors
(Faccio, 2010) and implementing bailouts (Faccio, Masulis, & McConnell, 2006). If firms can
successfully develop connections with new officials, they can obtain subsidies and financial support
1
At the city level, although an official's nominal term is typically 5 years, many local officials leave for other positions
within a term, and some serve for more than one term. During our sample period, 29.5% of officials serve for their position
for only 1 or 2 years; 69.9% of them serve their position for less than 5 years. Sources: http://www.economist.com/news/
china/21610316-weighing-economic-impact-anti-corruption-campaign-anti-graft-anti-growth
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The Chinese equivalent for new brooms sweep cleanis a new official usually does something unconventional and
sensational.
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See Shleifer and Vishny (1994), Fisman (2001), Svensson (2003), Khwaja and Mian (2005), Stulz (2005), Claessens,
Feijen, and Laeven (2008) for more discussion on this issue.
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from the government. Consequently, firms face weaker financial constraints and hold less cash (Han &
Qiu, 2007; Opler, Pinkowitz, Stulz, & Williamson, 1999).
Conversely, local official turnover can mechanically increase cash holdings. In agreement with
Julio and Yook (2012), policy uncertainty associated with turnover of government leaders can enhance
the value of waiting. As a result, firms reduce investment expenditure until policy uncertainty is
resolved. Therefore, cash holdings increase.
To test these predictions, I collect the personal information of city heads in China.
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I then match this
dataset with information on listed non-financial firms for the period 20022013. It is noteworthy that in
China, local officials are appointed by higher-level authorities (party committees or governments)
rather than elected competitively. These officials can be promoted or replaced at any time. Therefore,
turnover of local officials in China is largely immune from lobbying.
I begin by examining the effects of local official turnover on cash holdings. On average, firms
reduce their cash holdings by 3.1% when local official turnover occurs. I then investigate
heterogeneous effects between state-owned enterprises (henceforth SOEs) and privately owned
enterprises (henceforth POEs). SOEs are less concerned with political expropriation risk, because their
managers are semi-officials in the bureaucratic system (Chen, Jiang, Ljungqvist, Lu, & Zhou, 2016;
Feng & Johansson, 2014; Li & Zhou, 2005). In contrast, POEs are generally less connected with local
governments, more financially constrained (Allen, Qian, & Qian, 2005; Feng, Johansson, & Zhang,
2015), and more likely to become targets of rent seeking (Shleifer & Vishny, 1994). Therefore,
I conjecture that either the grabbing hand or the helping hand effects of local governments, if any,
should be more pronounced in POEs. Indeed, I find that the negative effects concentrate in POEs; the
average cash holdings of POEs decrease by 6.5% upon turnover of city heads, while the average cash
holdings of SOEs do not change significantly.
My research design assumes that local official turnover triggers changes in cash holdings. I take
steps to validate this assumption. To begin with, I conduct a dynamic test around the time when
turnover of city heads occurs. I find that cash holdings begin to decrease only after local official
turnover, but not before. Since the results do not provide sufficient evidence of a causal relation,
I conduct several additional tests. To address the concern that firms experiencing local official turnover
may be substantially different from other firms, I construct a propensity-score-matched sample to
examine whether the primary findings remain valid. Additionally, omitted variables may lead to
changes in both local official turnover and cash holdings, which could bias the estimation results.
Therefore, I employ an instrumental variable (IV) approach. I identify two IVs for local official
turnover, the city head's age in the preceding year and the percentage of other cities in the same
province that experience turnover of a city head in the current year. A two-stage least square (2SLS)
estimation is conducted using these two instruments. In addition, I employ the dynamic panel system
general method of moment (GMM) estimation to check the causal relationship between local official
turnover and cash holdings. Both the 2SLS and GMM estimations yield a negative and significant
relation between local official turnover and POE cash holdings. In addition, the primary results are
robust to multiple econometric specifications, various subsamples, and alternative definitions of the
main variables.
Next, I explore how the effect revealed above differs among subsamples. Using city-level
indicators of government quality provided by the World Bank Survey (Chen et al., 2014; Mako, 2006),
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City head refers to the secretary of the prefectural Chinese Communist Party Committee. As party chief, the secretary is
the most powerful political leader in the city, outranking the mayor. The secretaryhere is not the counterpart of the
secretary in other countries who do office work such as answering phone calls and arranging meetings. See section 2 for a
detailed description.
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