Political connection and firm diversification: evidence from China

Connections give diversified firms an advantage. This study investigates whether firms will be less diversified when the connections to the government are abruptly interrupted, using a dataset on the firm’s subsidiaries and the political connectedness of all listed private firms in China. In 2013, an unanticipated reform intended to combat corruption forced all politically connected independent directors of listed firms to resign. We find that those affected firms become less diversified after the reform. The estimation results are not driven by changes in the number of subsidiaries, government development goals, CEO’s political incentives, or other commercial system reforms. Placebo events for SOEs and firms’ academic background yield no effects. The effects are larger for local connections and stronger institutions. We also find that depoliticized firms are less likely to enter regulated and profitable industries and acquire less government economic support. Our results suggest that diversified firms could be ‘parasites’ of the economic-political institutions in emerging markets.