Political Connections, Government Subsidies And The Effectiveness Of The Delisting System

The delisting system is the cornerstone of Chinese stock market. On October 15,2014, China Securities Regulatory Commission issued "Several Opinions on the Reform and Strict Implementation of the Delisting System of Listed Companies", which took effect in the following month. Shanghai and Shenzhen two stock exchanges hereby revised the relevant provisions of the "Stock Listing Rules". Comparing with prior delisting policies, the new system is the most stringent one since the founding of the capital market in China.Nevertheless, during the year right after the implementation of the new delisting regulations (from November 2014 to November 2015), there are in total 22 companies of Shanghai and Shenzhen stock exchanges withdrawed from the market, less than 0.8% of all listed companies, while in the London Stock Exchange from 1997 to 2008 about 339 companies delisted annually, accounting for 12.3% of the total number (Croci et al,2014), and from 1998 to 2004 in the U.S. NASDAQ alone delisting number is about 4000 each year,20% of all listed companies (Harris,2006). In contrast, very few companies in Chinese capital market delist.Chinese capital market has not yet implemented the registration-based stock-issuing system. On December 27,2015, the National People's Congress (NPC) Standing Committee passed the authorization decision on the reform of stock issuance system. No later than March 2018, the registration system will take the place of the prevailing authorization system. Prior to its implementation, listing companies'shell resources are still of huge values, correspondingly, listed companies in financial straits threatened by the delisting warnings have the incentives to carry out shell protection campaigns, thus making it unlikely for the listed to delist.Ever since its come-into-being in 2001, China's delisting system has gradually become stricter, but due to the absence of registration system, shell resources are still of value, so the direct effect of the delisting system is not obvious, as indicated by the relatively small number of delisting companies. Cheng (2010) studied the 2001 launch of single financial indicator in delisting system, and found that it aroused a large number of listed companies' earnings management and asset restructuring behaviors to circumvent the delisting. Zhang (2015) carried out an empirical study on the 2012 implementation of the four financial indicators in the delisting system and its policy effect, which indicated that the new delisting criteria had certain effects and economic consequences.Previous literature showed the indirect effects of delisting system from different aspects, but basically, what makes those companies in financial distress stay in the market are the shell protection campaigns, and these campaigns are mostly backed up by financial subsidies from governments (Chen et al.,2008). Financial subsidies and political connections are generally positively related (Pan et al,2009). The stricter the delisting system, the stronger the incentive to protect the shell, the stronger the positive relationship between financial subsidies and political connections. Therefore, to measure how the relationship between financial subsidies and political connections changes over the years of delisting system reforms is to measure the policy effects of delisting system, and this is what this paper tries to do.The existing literature was mostly restricted to the impacts on companies' behaviors and performances on a certain regulation regime of the delisting system. Up to present, there hasn't been any research on investigating how the relationship between political connections and government subsidies changes over time.This paper contributes to the literature by examining the effectiveness of delisting system on a general scale without breaks, which is to examine the changes of the relationship between financial subsidies and political connections over the whole time range of delisting system reforms.How China's economic sectors get along with the corresponding political system is nothing like the funding for election campaign and senate lobbying in the western developed countries, and also differs from that in other transition economies. First of all, Chinese state-owned enterprises have a close relationship with the political system. In foreign data samples, most of the companies are privately owned and often obtain the political ties through spontaneous seeking and cultivation. In China, just the contrary, many listed companies are transformed from state-owned companies in the planned economy, in which senior executives ranging from CEOs and presidents to heads of departments usually were assigned to the position by the government and had good political backgrounds before the assignment. Therefore, political ties are deeply imprinted in these companies, as natural as DNA segments. Secondly, as a one-party country, China's stable political system directly leads to the stability of political connections. One ruling party rule made it impossible to have regime change ever since the founding of People's Republic of China. Unlike the timely change of regime in the multi-party ruling countries, political ties in China is relatively stable and consistent. Thirdly, China's laws and regulations are far from perfect, and yet the prevailing mechanism to protect property rights is also far from effective. In order to protect their properties from abuse, Chinese companies need to make the best of their political connections, instead of putting them at loose ends.In a word, political ties are deeply-rooted leftovers from Chinese contemporary history, are widespread in Chinese companies and are active in business practices. In this particular context, the measurement of politically connected Chinese companies should be made in a more targeted way.The existing literature usually used dummy variables to measure political connections, regarding the companies with no less than one senior executive once a civil servant as politically connected and those without as not connected, but this treatment doesn't make any distinction on the degree of political connections in each company and of course doesn't satisfy the needs of researches in the Chinese system background, in that:First, many senior executives of Chinese companies once worked or even at present work for the government. In this case, the dummy variables could take too many companies as the same in terms of the political connection and miss out much information that is valuable to the research. Second, using dummy variables can't distinguish between strong and weak political connections. But it is particularly true that, in China, political resources corresponding to different administrative levels are significantly different. The higher one's administrative level is, the more political resources one can obtain, the more benefits one can bring to the company. Third, the dummy variables don't take into account the influence of groups. If the company has more than one executive with political connections, it can scale through their group influence.Therefore, to work out a good measure, this paper follows what Wang and Wu have done in the Chinese Listed Companies Political Influence Index. Take into account the administrative levels by grading each senior executive according to the highest administrative level in resume as one's political influence score, and add up all senior executives' political influence scores to cover the group influence, the sum making up the political influence score of the company.The empirical result shows from 2001 to 2013, a positive relationship between political ties and government subsidies, and the positive impacts grow stronger with the introduction of new delisting rules, confirming what is hypothesized in the previous part. Therefore, we can conclude that China's delisting system reforms are effective, however in a not-so-positive way, making it more likely for profit manipulation for the sake of loss turnover and shell keeping. Though indeed, with the implementing of new rules, the listed companies need to have better and more comprehensive financial performances to stay in the market. For the new rules of 2014, there is a different story, which shows less positive connectedness between political ties and government subsidies, indicating that with the introduction of spontaneous delisting rules and the registration-based share issuing, the shells are less valued and it could be the pretext of a shell-free era for the Chinese stock market.All in all, an effective delisting system is essential for a sophisticated capital market. When functioning well, it ensures the listed companies are in good conditions, protecting the confidence of the investors and the sustainability of the capital market. A more and more effective delisting system in China is pleasant to see, but it had no direct effect but gave rise to the government subsidy growth and stronger impact on government grants from political ties. On system reform, China still has a long way to go.