Ownership Structure, Institutional Development, and Political Extraction: Evidence from China

This paper examines how ownership structure and institutional development influence the liquidity management and investment policies of firms, in response to the threat of political extraction in China. First, we document evidence that firms controlled by private entrepreneurs hold less cash reserves than their state-owned counterparts. In addition, cash holdings (investments) is positively (negatively) related to the strength of economic institutions. The results are consistent with the hypothesis that managers of private firms and firms located in provinces with weaker institutions have incentives to protect their assets from being expropriated by politicians, through holding less cash (which are easier to extract) and pursuing more investments in fixed assets (which are harder to extract). Finally, we find that firms with close connections to politicians hoard cash reserves and display lower investments than their non-connected counterparts. This suggests that political connections mitigate the threat of political extraction for those connected firms.