Escaping political extraction: Political participation, institutions, and cash holdings in China

- We study the effects of political participation on cash holdings in Chinese firms.
- Political participation is positively related to cash holdings.
- Political participation is negatively associated with investments.
- The effects on cash holdings and investments depend on institutional quality.

We study the effects of political participation on holdings of liquid assets in Chinese privately controlled listed firms. Previous research has shown that the risk of political extraction by politicians and bureaucrats in countries with weak institutions has an adverse effect on holdings of liquid assets. We propose that political participation by private entrepreneurs can function as a means to alleviate some of that risk. We find that political participation in China is positively related to cash holdings in regions with weaker institutions. Our results also show that investments in “hard” assets such as PPE and inventories, which are less susceptible to the grabbing hand, are higher in regions with weaker institutions, but that political participation mitigates this effect. Finally, cash holdings have an insignificantly positive effect on firm value on its own, while political participation is positively associated with firm value. The interaction between cash holdings and political participation is positively related to firm value, again suggesting that political participation facilitates the holding of liquid assets in China, which in turn results in better firm performance.