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r Academy of Management Journal

2016, Vol. 59, No. 5, 18011822.


http://dx.doi.org/10.5465/amj.2014.0425

THE DARK SIDE OF BOARD POLITICAL CAPITAL:


ENABLING BLOCKHOLDER RENT APPROPRIATION
PEI SUN
Fudan University
HELEN W. HU
University of Melbourne
AMY J. HILLMAN
Arizona State University
Resource dependence theorists argue that boards of directors with political capital can
benefit focal firms by reducing uncertainty and providing preferential resources. Here,
we develop theory regarding the downside of board political capital. The problem of
principalprincipal agency is evident in many parts of the world, and we argue that
board political capital can further exacerbate it by enabling large blockholders to undertake more appropriation of firm wealth. Further, we explore how this enabling effect
is moderated by ownership-, industry-, and environment-level contingencies. We find
empirical support for our arguments using 32,174 directors in 1,046 Chinese listed firms
over the period 20082011. Our study sheds light on new ways in which resource dependence and agency theories can be integrated to advance the extant research on board
governance and corporate political strategy.

secure external resources, thus benefiting a firm in


developed and emerging economies alike (e.g., Faccio,
2006; Hillman, 2005; Peng & Luo, 2000; Zheng, Singh,
& Mitchell, 2015). In this paper, we offer an important
caution against this general claim: board political
capital can also have a dark side.
We contend that its dark side arises from the role
that board political capital can play in enabling blockholder rent appropriation. Different from principal
agent managerial agency conflicts, the central agency
problem that exists in many parts of the world concerns the conflicts between large and small shareholders, often termed principalprincipal conflicts
(Chang, 2003; Dalton, Hitt, Certo, & Dalton, 2007;
Dharwadkar, George, & Brandes, 2000; Gilson, 2006;
La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000;
Young, Peng, Ahlstrom, Bruton, & Jiang, 2008). Here,
we define principalprincipal agency problems
as the conflicts between controlling blockholders
(henceforth, blockholders) and a large number of
small shareholders over firm surplus and the associated opportunism on the part of blockholders of
appropriating firm wealth. Such appropriation can
take a variety of forms: aside from installing unqualified cronies in executive positions and pursuing projects that advance their private interests,
blockholders can divert assets and cash flows away

Because all firms are dependent upon government


entities to some degree (Pfeffer & Salancik, 2003),
scholars have built a body of theory and empirical
analyses related to corporate political strategies,
defined as actions that firms take to influence public
policy in their favor (Hillman, Keim, & Schuler,
2004). One such tactic is appointing individuals to
the board of directors who have served in some political capacity (e.g., Hillman, 2005; Lester, Hillman,
Zardkoohi, & Cannella, 2008; Sun, Mellahi, & Wright,
2012). At the board level, this is often termed board
political capital because it represents not only
directors human capital in terms of government
knowledge and experience, but also their social capital or connections to government decision makers.
Previous research suggests that board political capital
serves to reduce environmental uncertainties and

We gratefully acknowledge Laszlo Tihanyi (associate


editor) and three anonymous reviewers for their constructive and insightful remarks during the review process.
We also thank the participants of our seminars held at
Shanghai University of Finance and Economics and the
University of Melbourne for their valuable comments. Pei
Sun appreciates the financial support from Chinas National Natural Science Foundation (Grant number:
71102014).
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Academy of Management Journal

from publicly traded companies to parent firms


or unlisted subsidiaries through self-dealing transactions. They range from outright theft to subtler
activities such as transfer pricing and diluting the
value of minority investors stocks (Anderson &
Reeb, 2004; Gilson, 2006; La Porta et al., 2000).
By bringing together work on corporate political
strategies grounded in resource dependence theory
(Hillman, Withers, & Collins, 2009; Pfeffer & Salancik,
2003) with the agency perspective of blockholder rent
appropriation (Coff, 1999; Dharwadkar et al., 2000;
Young et al., 2008), we argue that boards with political capital can be leveraged by blockholders to augment their bargaining powers over firm surplus,
enabling them to extract more wealth at the expense of
minority shareholders and firm performance. This is
particularly the case when boards can be dominated
or captured by company blockholders. Specifically,
we identify the legal/regulatory and market-based
mechanisms through which board political capital
can act to tilt the power balance in favor of blockholders. Further, we explore boundary conditions
under which this enabling effect may be more or less
severe. They concern ownership-, industry-, and
environment-level contingencies that influence the
mechanisms through which board political capital
facilitates blockholder rent appropriation.
We aim to advance theory on several fronts with
this study. Pfeffer and Salancik (2003) suggested that
firms seek directors who have the ability to manage
interdependence between the firm and the government. In Pfeffers foreword to the new edition of their
book, he observed that there is much less research
than there should be on the effects of various cooptive relations and political strategies on organizational outcomes (Pfeffer & Salancik, 2003: xix). He
also noted a strange omission (Pfeffer & Salancik,
2003: xix) in that past research rarely considered the
conditions under which the various cooptive strategies could work. Similarly, Hillman and colleagues
(2009: 1419) noted that, although the basic tenets of
RDT [resource dependence theory] are well supported, it has not experienced substantial theoretical
development or refinement. Notably, both reviews
of the theorys progress still suggest the focus be on
benefits of cooptive strategies. Therefore, our first
contribution to resource dependence theory is to identify a condition under which there may be potential
costs of co-optation by boards with political capital.
Second, we cast new light on the integration of
resource dependence and agency perspectives on
boards of directors (Hillman & Dalziel, 2003). While
the resource dependence logic holds that boards play

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a critical role in providing resources, it generally


assumes that the acquired resources will benefit the
whole organization. We, however, raise the question
of to whom the board capital provides resources.
Since agency theory shares a focus on power differentials between economic agents with resource dependence theory, we build upon recent work on
principalprincipal agency conflicts to show that the
political connections this board capital confers may
heighten blockholder opportunism and enable more
rent appropriation. Different from extant research on
agencyresource dependence integration that highlights a positive role of board capital in addressing
managerial agency problems (Carpenter & Westphal,
2001; Kroll, Walters, & Wright, 2008; Tian, Haleblian,
& Rajagopalan, 2011), we suggest a new avenue for
theoretical integration of the two perspectives by explicating the mechanisms through which board capital can
play a perverse part in exacerbating agency conflicts.
Third, our study extends agency theory. Responding to the call for more research on contexts different
from the traditional conceptualization of managerial
agency problems (Tihanyi, Graffin, & George, 2014),
we contribute to deepening understanding of the organizational antecedents to the principalprincipal
agency problem. While previous literature focused
largely on the institutional/environmental determinants of this agency conflict (Young et al., 2008), ours,
to the best of our knowledge, is the first to introduce
the role board capital may play with blockholders
in affecting this agency conflict.
Fourth, we contribute to the literature on corporate
political strategies (Hillman et al., 2004; Lux, Crook,
& Woehr, 2011; Mellahi, Frynas, Sun, & Siegel, 2016).
The common assumption in this literature is that political strategies are beneficial and at worst ineffective.
We identify a specific mechanism through which board
political capital can play a detrimental role. Under
concentrated ownership and board capture by blockholders, there is a potential irony that the very rentgenerating capital can be leveraged for rent extraction.
We chose China as the empirical setting for this
study. The countrys political regime has been stable
and government influence has remained profound in
its corporate sector, and, therefore, building political
connections is critical in value creation and business
success in China (Shi, Markoczy, & Stan, 2014). Meanwhile, the misappropriation of firm wealth by large
shareholders has been well documented by media and
academic studies (e.g., Hu, Tam, & Tan, 2010; Jiang, Lee,
& Yue, 2010). Hence, the salient value of building political connections and the severity of blockholder rent
appropriation make the Chinese corporate sector an

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Sun, Hu, and Hillman

ideal context in which to examine the potential dark


side of board political capital.
THEORY, CONTEXT, AND HYPOTHESES

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matter how the linkage was formed, previous empirical research has confirmed the relevance of this
resource dependence logic in the Chinese context (Li
& Zhang, 2007; Peng, 2004; Peng & Luo, 2000; Zheng
et al., 2015).

Board Political Capital


Resource dependence theory highlights the resource provision role of boards of directors (Hillman
& Dalziel, 2003; Pfeffer & Salancik, 2003). According
to this perspective, business organizations face
a multitude of interdependencies with external entities. Therefore, organizational survival and growth
are dependent on their ability to procure resources
from, and manage uncertainties caused by, external
constituents. Among these constituents, government
is one of the most difficult environmental dependencies to control (Hillman et al., 2009: 1412). Pfeffer
and Salancik (2003: 189, 190) suggested the organization, through political mechanisms, attempts to
create for itself an environment that is better for its
interests as well as build political power in the
external environment, to be used at some future
time for the organizations interests.
Boards of directors help firms manage power imbalances with external entities. Specifically, research in this tradition suggests that, if firms have
directors with connections to external entities on
which they are dependent, these board members will
ease uncertainty, lower transaction costs, and otherwise benefit the firm. Scholars suggest that board
political capital can provide organizational legitimacy, opportunities to network with political actors,
and a wide range of regulatory and financial resources controlled by political institutions (Goldman,
Rocholl, & So, 2013; Hillman, 2005; Sun et al., 2012).
As Hillman and colleagues (2009: 1413) argued,
performance benefits accrue to firms that create
linkages with the political environment. This assertion
is supported by empirical studies finding performance
benefits of political ties (Bonardi, Holburn, & Vanden
Bergh, 2006; Hillman, 2005; Hillman, Zardkoohi, &
Bierman, 1999).
In the Chinese context, politically connected directors can be former government and Communist
Party officials entering the business sector or successful entrepreneurs/professionals entering politics as members of Chinas legislative bodies.1 No
1

Chinas Civil Servant Law forbids acting government


and Party officials from holding posts in any profit-making
organizations. Also, most of the legislative body members
in China do not work full-time.

PrincipalPrincipal Agency Problems


Once organizational rents are generated, they
are subject to appropriation by various stakeholder
groups (Coff, 1999). It is not uncommon that a large
portion of the original rents fail to stay within the
firm but flow to certain groups of stakeholders (David,
OBrien, Yoshikawa, & Delios, 2010). The conventional principalagent conflicts (Jensen & Meckling,
1976) can be seen as bargaining and the allocation of
rents between dispersed shareholders and management. Furthermore, agency theory is a theory about
power (Finkelstein, Hambrick, & Cannella, 2009:
246), in that the outcome of rent allocation between
management and shareholders is largely due to their
power differential (Mizruchi, 1983).
Agency theory scholars recognize that shareholders are a heterogeneous group featuring conflicts
and potential owner opportunism (Boss, Connelly,
Hoskisson, & Tihanyi, 2013; Connelly, Hoskisson,
Tihanyi, & Certo, 2010; Dharwadkar et al., 2000;
Hoskisson, Hitt, Johnson, & Grossman, 2002; Young
et al., 2008). In the majority of the world, concentrated
ownership is the norm (La Porta, Lopez-de-Silanes, &
Shleifer, 1999). While this ownership structure reduces managerial agency costs, it gives rise to the
principalprincipal agency problem. Specifically,
blockholders can appropriate firm surplus at the
expense of minority shareholders by extracting
assets and profits away.
According to agency theory, the severity of this
problem is contingent upon two important disciplinary mechanisms: legal/regulatory and equity
market disciplines. First, investor protection ensured by country-level legal and regulatory regimes
serves as a crucial institutional safeguard against
blockholder opportunism (La Porta et al., 2000).
Enforced legal rules and regulations dampen blockholder appropriation by imposing significant constraints and sanctions. Where there are robust legal
and regulatory regimes protecting the interests of
minority investors, blockholders are less likely to
abuse their power.
Second, a well-functioning equity market can play
an important role in disciplining blockholders, because extracting firm surplus sends a bad signal to
the market, which will harm the price of the shares

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held by the blockholder (Gomes, 2000). This disciplinary effect will be particularly relevant when the
firm wants to revisit the equity market for offering
new shares from outside investors (Durnev & Kim,
2005). Thus, reliance on future equity financing
constrains blockholders opportunism.
In sum, these two mechanisms can mitigate the
blockholder agency problem through influencing
the power balance between the two types of shareholders. We develop theory articulating how board
political capital can influence blockholder opportunism via the two mechanisms. We first introduce
the Chinese context and then integrate it with our
theory development to derive testable hypotheses.
Research Setting
The Chinese equity market was once populated by
many former state-owned enterprises (SOEs), where
government agencies retained significant ownership
stakes after share issue privatization. It was not until
the late 1990s that private businesses started to float
shares. Regarding blockholder identity, a majority of
the parent SOEs were in turn controlled by regional
and central government agencies; private parent
companies were owned and managed by entrepreneurs and their founding teams.
No matter whether an original firm was state
owned or private, it typically underwent a process of
carve-out listing (Walter & Howie, 2006). That is,
the original firm carved out its profitable assets and
business units to establish a new corporate entity for
flotation. Meanwhile, the original firm was transformed
into a holding company, which received controlling
ownership stakes in the new entity. After the new
company was listed, outside investors became minority shareholders. Consequently, there exists a
fine line between the holding company and its listed
subsidiary in operational and financial issues. Many
executives are tied to the blockholders and have
a limited sense of obligation to outside investors.
On paper, minority shareholders in China enjoy
sound legal protection against appropriation. In
practice, however, such legal rules are ineffective,
owing to massive enforcement failures (Jiang et al.,
2010; Yiu, Xu, & Wan, 2014). Because the Chinese
judicial system is not independent of the state but an
extension of the political authority, regulatory agencies
play a more important role in investor protection.
Stock market regulation rests with the China Securities
Regulatory Commission (CSRC), which was modeled
after the U.S. Securities and Exchange Commission
and is supposed to enforce a uniform set of regulatory

October

rules on all the market participants. The CSRC has


issued a series of administrative rules and orders to
curb blockholder rent appropriation. Since the mid2000s, corresponding legal changes have made controlling shareholders and management team members
who divert company assets subject to potential civil
and even criminal liabilities. Nevertheless, the penalties are rather lenient and not well specified (Jiang &
Kim, 2015: 210). According to Liebman and Milhaupt
(2008: 943), the number of sanctions has been modest
given the ubiquity of insider misdeeds, and a vast
majority of them did not result in investor lawsuits.
Qian and Yeung (2015: 262) found that, although
regulation makes controlling shareholder tunnel
[misappropriate cash flows] less aggressively, such
practice remains common and continues to spread.
With respect to board governance, the CSRC in
2002 stipulated that boards of directors act in the best
interests of the company and treat all shareholders
equally. In 2003, the CSRC required that one third of
board directors be independent in all listed companies. Most listed companies comply by appointing
the minimum number of independent directors (one
third), but executives and representatives from
blockholders still are the majority of the board
(Jiang & Kim, 2015). Moreover, since blockholders
have effective control of the nomination of both
executive and outside directors, it is unlikely that
outside directors will exercise their fiduciary duties
to protect the interests of minority shareholders (Ma
& Khanna, 2016).
Case illustration. Xiwang Food Co. Ltd is one of
the Chinas largest corn oil producers. More than
40% of the companys shares are held by its unlisted
parentthe Xiwang Group, which was founded in
1986 by a rural entrepreneur, Wang Yong. The group
is a conglomerate operating in food, steel, and real
estate sectors; its founder has been in the Forbes China
Rich List since 2010. Within less than 12 months during 2011 and 2012, the group appropriated RMB 600
million (U.S. $97 million) from its listed subsidiary.
This fund transfer was achieved mainly through the
manipulation of the other receivables account in the
firms balance sheets, which resulted in a direct fund
transfer to the unlisted parent company (more details
about this tactic can be found in our empirical section). Although the activity was disclosed to the public
and openly reprimanded by the Shenzhen Stock Exchange in 2013, no civil or criminal sanctions followed, despite repeated pledges since the mid-2000s
by Chinese regulatory agencies to punish wrongdoers.
The listed companys board had significant political capital during the same period. Out of nine board

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Sun, Hu, and Hillman

members, six were executive directors (including the


founder and his son) and three were independent.
Four of the nine were politically connected: the
founder had served two terms as a member of the
Provincial Peoples Congress and was a member of
the National Peoples Congress then; two independent directors also had long working experience in
Chinas central and regional government agencies.
Ironically, the three independent directors even
made a public statement in April 2012, openly endorsing the accuracy of the companys financial
reports. Again, none of these directors has ever been
held accountable for the misstatement.
Board Political Capital and Blockholder Rent
Appropriation
In the context of board capture by blockholders,
we propose that board political capital can exacerbate the principalprincipal agency problem by
encouraging more appropriation of firm wealth.
Specifically, board political capital acts to buffer
the discipline of legal/regulatory rules and that
of the equity market. First, self-dealing activities
undertaken by blockholders can invite legal and
regulatory sanctions, which are supposed to be
enforced by courts and securities-market regulatory agencies. However, the enforcement of legal
and regulatory rules of investor protection is by
no means immune from political influence. In the
case of the judicial system, the courts are far from
independent of politics (Ginsburg & Moustafa,
2008). Recent empirical studies in China confirm
this: politically connected firms are more likely to
use courts for dispute resolution (Ang & Jia, 2014),
and, if a politically connected firm is sued, it suffers
smaller shareholder wealth losses and has a higher
likelihood of a favorable appeal (Firth, Rui, & Wu,
2011). Because investor lawsuits against blockholder misdeeds in China are filed in the region
where the focal company is headquartered, ties
developed between firm and local political agencies
can result in local favoritism in the courts and uncertain enforcement prospects (Liebman & Milhaupt,
2008: 943).
Similar pressures make it difficult for regulatory
officials to discipline politically connected firms.
Early political economy literature (e.g., Stigler, 1971)
suggests that regulatory agencies can be captured
by interest groups who demand regulatory arrangements operate for their private benefits. Moreover,
firms can employ their political capital to flex their
muscles to regulators (Gordon & Hafer, 2005). Even

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in a regulatory regime as robust as that of the United


States, research reveals that political connections
through long-term contributions and lobbying can
lead to reduced oversight from securities regulators
(Correia, 2014; Yu & Yu, 2011). In the Chinese context, Berkman, Cole, and Fu (2010) have suggested
that minority shareholders dont expect regulators to
strictly enforce investor protection rules on politically connected firms. What is more, the enforcement of the sanctions has tended to be uneven across
companies. For example, Sun and Zhang (2006)
found politically connected board chairmen and
CEOs less likely to receive penalties after the revelation of corporate fraud by Chinese regulatory
bodies. In short, board political capital can serve to
buffer the legal and regulatory disciplinary pressures
against blockholder appropriation.
Second, blockholders who engage in persistent
rent misappropriation may face punishments from
the equity market and outside investors in the form of
discounts in firm value and loss of future equity financing opportunities (Durnev & Kim, 2005; Gomes,
2000). Board political capital, however, can assist
blockholders in gaining alternative access to resources and financing channels. Previous studies
demonstrate that political capital facilitates the
provision of bank financing (Claessens, Feijen, &
Laeven, 2008), favorable policies (Bonardi et al.,
2006), and other benefits such as government contracts (Goldman et al., 2013). As such, politically
connected boards can significantly reduce blockholders reliance on equity finance, thus diminishing
the effect of market-based disciplines.
For instance, Leuz and Oberholzer-Gee (2006)
demonstrated that Indonesian firms with close political networks were less likely to undertake overseas
flotation, which suggests that blockholders are less
willing to face scrutiny from foreign (i.e., developed)
capital markets. Chaney, Faccio, and Parsley (2011)
found a lower quality of accounting information disclosure in politically connected firms than their unconnected peers, but the connections they hold have
made them largely insulated from the sanctions
against poor disclosure quality. Therefore, we propose the following hypothesis:
Hypothesis 1. Board political capital will increase
the severity of blockholder rent appropriation.

Ownership-Level Moderator: Blockholder Identity


Prior research has recognized that the functioning of corporate boards can vary with different

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types of controlling shareholders (Desender, Aguilera,


Crespi, & Garcia-Cestona, 2013). In the Chinese context, dominant blockholders can be government or
private entities. In the former case, government status
itself endows blockholders with substantial power
advantages over minority investors, independent of
a politically connected board. A priori, government
blockholders are not more likely to appropriate firm
wealth than their private counterparts (Jiang et al.,
2010; Jiang & Kim, 2015), because government entities
lack the direct financial beneficiaries inherent with
private blockholders. Even if government blockholders did want to extract rents from listed firms,
they would not need a politically connected board
to do so. Courts and regulatory agencies would be
hesitant to interfere with government blockholder
misdoings. And, government blockholders can reduce the firms reliance for equity financing by providing alternative financial and policy resources.
In contrast, private blockholders can personally
benefit from rent appropriation but likely need a politically connected board to facilitate it, because the
power advantages of private blockholders over small
shareholders will be more susceptible to regulatory
and market constraints. First, courts and regulatory
bodies will not hesitate to punish private blockholders, so these blockholders have stronger motives
to develop and exploit board political capital as
a buffer (Ang & Jia, 2014). Second, prior research
shows that, owing to the lack of formal institutional
support, private firms in China have more incentives
to cultivate and exploit ties to government officials
(Park & Luo, 2001; Xin & Pearce, 1996). Here again,
board political capital may alleviate private blockholders concern about capital market discipline
through the provision of alternative financing channels (Claessens et al., 2008; Li, Meng, Wang, & Zhou,
2008). This leads to our second hypothesis:
Hypothesis 2. The effect of board political capital on the severity of blockholder rent appropriation will be heightened if the controlling
blockholder is a private entity as opposed to
a government entity.

Industry-Level Moderator: Industry Regulation


The role of industry regulation has long been
a factor in corporate political strategy (Bonardi et al.,
2006; Schuler, Rehbein, & Cramer, 2002) and again
is rooted in resource dependence theory (Hillman
et al., 2004). Since regulated firms are more dependent on government policy, firms in heavily regulated

October

industries tend to engage in more political activities


(Hillman & Hitt, 1999), and board political capital
in heavily regulated industries is more likely to
improve performance (Hadani & Schuler, 2013;
Hillman, 2005).
Because the government holds more influence and
power over regulated industries, we expect board
political capital to be more salient in helping blockholders insulate themselves from legal/regulatory
and market-based disciplines against rent appropriation. In heavily regulated industries, firms and
regulators more frequently interact and may develop
long-term relationships. In many cases, the politically
connected directors are former regulators (Lester
et al., 2008). As a result, these directors are more
likely to identify themselves as allies of the blockholders and be more dedicated to contributing their
political capital (Hillman, Nicholson, & Shropshire,
2008). The long-term relationships and strong selfidentification with the blockholders can result in
more favorable legal/regulatory treatments and
supply of financial resources. This leads to our third
hypothesis:
Hypothesis 3. The effect of board political capital on the severity of blockholder rent appropriation will be heightened in heavily regulated
industries.

Environment-Level Moderator: Subnational


Institutional Contingencies
The relevance of local institutional contingencies
is well recognized (e.g., Kozhikode & Li, 2012). Large
economies, such as China, feature substantial heterogeneity in regional institutions. Although China
is a unitary state with uniform legal and regulatory
frameworks, laws and policies are open to interpretation and revision by local authorities. As such,
firms face different degrees of property rights protection and government intervention across regions
(Shi, Sun, & Peng, 2012).
As a result, the strength of legal and regulatory
constraints on blockholder rent appropriation varies
across regions. In regions with more developed institutional environments, enforcement of legal and
regulatory rules is less likely to be manipulated by
politicians. Therefore, the value of board political
capital will be less in regions with stronger legal and
regulatory constraints and greater in regions with
less-developed institutions. Similarly, the magnitude
of market-based discipline on blockholders varies
across regions. More developed market-supporting

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institutions lead to a more equitable environment that


restrains a biased allocation of financial resources.
This will in turn sharpen the force of equity market
discipline if blockholders engage in excessive appropriation. Conversely, the facilitating role of board
political capital is to be more salient for companies
located in less-developed institutional environments, because the corresponding political actors
have more resources at their disposal to dampen
the discipline of equity markets. This leads to our
fourth hypothesis:
Hypothesis 4. The effect of board political capital on the severity of blockholder rent appropriation will be weakened in regions with more
developed institutional environments.

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directors possessed political capital, 3,178 of whom


were independent.
We used CSMARs China Stock Market Financial
Information database, China Listed Firms Corporate
Governance Research database, and China Listed
Firms Shareholder Research database to collect
firms financial and corporate governance information. We also collected provincial-level data
from the National Bureau of Statistics and the
National Economic Research Institute (NERI), a
prestigious non-governmental research center in
China. All these databases have been commonly
used in prior research on Chinese firms (e.g., Li &
Qian, 2013; Wang & Qian, 2011).
Dependent Variable

METHODS
Data and Sample
Our dataset included all Chinese manufacturing
firms listed on the Shanghai Stock Exchange or
Shenzhen Stock Exchange from 2008 to 2011.
Manufacturing firms represent the bulk of corporate China, and accounted for more than 60% of
the listed firms. The sector contains ten two-digit
subsectorsfood and beverage, textile, wood and
furniture, paper and printing, petrochemical, electronics, machinery, metallurgical, pharmaceutical,
and other manufacturingthat provide considerable industry variations. On the basis of a total of
1,295 manufacturing listed firms identified during
the study period, we excluded 197 firms that were
traded for less than one year and 52 firms with missing
data. This led to an unbalanced panel of 1,046 firms
and 2,854 firm-year observations.
In China, publicly listed companies are required to
disclose their directors biographical sketches (including education, professional experience, career
history, and current position) in their annual reports.
To study the political experience of board members,
we hired GTA Information Technology, the provider
of the China Stock Market and Accounting Research
(CSMAR) database, to manually code the political
experience of each individual director of all the
sample firms from the biographical sketches. A team
of four well-trained researchers spent six months
completing the coding of the directors. The coding
results were subsequently verified by the two bilingual co-authors. After excluding 83 directors with
missing information, a total of 32,174 individual directors were included in the study, with 11,739 independent. Among all the directors coded, 5,551

Measuring blockholder appropriation of corporate wealth is challenging, in that the practice is illegal and can take a variety of forms. Fortunately,
prior studies in the Chinese context (Jiang et al.,
2010; Liu & Tian, 2012; Qian & Yeung, 2015) have
identified a rather transparent form of tunneling
that borders on outright fund diversion to controlling blockholdersintercorporate loans recorded
as other receivables (OREC), an accounting item
in Chinese corporate balance sheets. Technically,
this account refers to any receivable amounts and
temporary prepayments other than those recorded
as notes and accounts receivables. In reality, given
that the disclosure requirements for OREC are not
well specified, this account reflects related-party
transactions for non-operational purposes, especially loans to parent companies and their unlisted
subsidiaries.
In short, tunneling through OREC has been regarded as a particularly brazen form of corporate
abuse, in which controlling shareholders . . . siphon
billions of RMB from hundreds of Chinese listed
companies (Jiang et al., 2010: 1). Therefore, we
measured the severity of large shareholder appropriation by the value of a firms other receivables over
total assets (ORECTA). Jiang and colleagues (2010)
documented the regulatory moves to curb the
abuse of ORECTA in the mid-2000s, but anecdotal
evidence suggests the persistence of this fund diversion practice. For instance, China Securities
Journal (2012) reported that a total of RMB 3.4
billion (U.S. $540 million) was diverted from 60
listed companies during 2011. In summary, while
ORECTA doesnt capture all blockholder rent appropriation, it serves as a valid and parsimonious
proxy in our research context.

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Academy of Management Journal

Independent and Moderating Variables


Board political capital. Following prior studies
(Faccio, 2006; Hillman, 2005), we coded 1 if a director had current or former political experience,
and 0 otherwise. A director was deemed to have
political experience if s/he was a current member in
Chinese legislative bodies (i.e., the National Peoples
Congress and the Chinese Peoples Political Consultative Conference) or was a government official
before joining the company. We employed two ratios
to measure the stock of a companys board political
capital (PC): the firstBoard PC Ratiowas the
percentage of all directors on the board who had
political experience, and the second measure
Outside Board PC Ratiowas the percentage of all
independent directors with political experience.
While the former measures political capital arising
from all board directors, the latter focuses on the role
of external political agents that may have been coopted by company blockholders.
Controlling blockholder identity. Detailed information about ownership and control has been
available since 2001, when the CSRC required all
listed companies to disclose details of their controlling shareholders. Thus, we constructed a binary
variable, Private, coded 1 if a companys controlling blockholder was private, or 0 if a government
agency.
Industry regulation. Following prior literature
(e.g., Hadani & Schuler, 2013; Hillman, 2005), we
used a binary variableRegulated Industryto denote the significance of government regulation in the
sample firms. Based on the two-digit sectors stated
earlier, a firm was coded 1 if it belonged to one of
the following industriesPetrochemical, Pharmaceutical, Metallurgical, and Machineryand 0
otherwise. This is because these capital-intensive,
heavy industries are still subject to enormous influences from the Chinese states industrial policies.
Subnational institutional environments. To measure the quality of regional institutional environments, we used the NERI index of marketization in
Chinese provinces (Fan, Wang, & Zhu, 2011). This
index has been established by NERI for more than
a decade and is widely used to examine Chinas regional institutions (Li & Qian, 2013; Shi et al., 2012;
Wang & Qian, 2011). The yearly index assesses the
quality of market-supporting institutions in Chinese
provinces along five dimensions: the relationship
between the government and the market, the development of the private sector, the product market, the
factor market, and market intermediaries and legal

October

environments. A weighted average of the scores in the


five dimensions results in the overall index for each
province in each year. We matched the index with
sample firms in the provinces in which they were
located. Since the yearly indices are available only
from 1997 to 2009, we allowed for a two-year lag in
this variable to predict its effect on blockholder appropriation. For instance, firms 2011 ORECTA data
were regressed on their corresponding marketization
index in 2009.
Control Variables
We included governance-, firm-, and regionallevel control variables. We first controlled for potential ownership effects. Blockholder Ownership
measured the percentage of ownership stakes held
by the largest shareholder of the firm. Common
Blockholder was a binary variable that equaled 1 if
a listed firm shared the same controlling blockholder
with another firm in our sample. This variable serves
to capture any potential business group effects on
blockholder rent appropriation (Chang, 2003). Since
Chinese listed companies are required to disclose
their ten largest shareholders in their annual reports,
we also measured Blockholder Balance by the Herfindahl index, which equaled the sum of the squares
of the shareholding percentages from the second- to
the tenth-largest shareholders. This variable captures the potential effect that other large blockholders can have on balancing the power of the
largest blockholder.
Second, we controlled for board-level governance
effect. CEO Duality was a binary variable equal to 1
if there was a combined role of CEO and chairperson
on a board, and 0 otherwise. Board Independence
was measured by the percentage of independent directors. Board accounting/finance expertise was measured by the percentage of independent directors with
accounting and financial expertise, denoted as Board
Acc/Fin Ratio. This is an important control variable
because these outside directors are well versed in internal controls and the evaluation of financial statements, so they may curb blockholder appropriation.
We identified directors accounting and finance
expertise from the same biographical information
mentioned earlier. Following the prior literature
(DeFond, Hann, & Hu, 2005), a director was deemed
an accounting/financial professional if they had the
following experience: certified accountant, auditor,
corporate controller, principal or chief accounting/
financial officer, or a senior executive in investment
banking or the commercial banking industry.

1.00
20.06*
0.61
0.49
1.00
20.01
0.29*
0.48
0.50
1.00
0.03
20.01
0.00
0.06
0.09
1.00
0.68*
0.08*
0.00
0.01
0.29
0.19
1.00
0.11*
0.10*
0.08*
0.02
0.02
0.13
0.07
1.00
0.18*
0.09*
0.11*
0.04*
20.02
0.00
0.36
0.05
1.00
0.05*
0.04*
0.03
0.02
0.34*
20.02
0.18*
0.26
0.44
1.00
0.08*
0.01
20.03
0.01
0.00
0.17*
20.01
0.14*
0.02
0.03
1.00
20.05*
20.13*
20.04*
20.00
20.01
20.00
20.24*
20.00
20.02
0.10
0.31
1.00
0.06*
20.10*
20.05*
0.06*
0.00
20.02
20.03
20.11*
0.03
0.05*
0.38
0.16
1.00
0.06*
20.01
0.00
20.02
0.02
20.01
20.01
20.02
0.03
0.02
0.01
0.48
8.49
1.00
0.00
20.02
20.01
0.02
0.02
0.02
0.00
20.01
20.02
0.04*
0.01
20.01
0.16
1.99
1.00
0.04*
0.00
20.07*
0.04*
20.12*
20.12*
0.02
0.04*
0.01
0.03
20.11*
0.05*
20.11*
0.49
0.38
1.00
20.09*
0.00
0.01
0.05*
20.08*
0.13*
0.18*
0.02
0.03*
0.05*
0.05*
0.25*
20.06*
0.79*
9.55
0.78
1.00
20.04*
0.09*
20.05*
0.02
0.21*
0.15*
20.02
20.20*
0.00
20.13*
20.11*
20.05*
20.35*
0.01
20.03*
21.49
1.30
1.00
20.19*
20.11*
0.24*
0.09*
20.01
20.14*
20.05*
20.04*
0.00
0.04*
0.08*
0.05*
0.03*
0.09*
20.01
20.09*
0.02
0.04

Notes: N 5 2,854. Asterisk * denotes statistical significance at or below 5% level.

Table 1 presents descriptive statistics and pairwise correlations. The value of ORECTA is rather
significant in sample companies, with the sample mean
accounting for approximately 2% of the total assets.
Table 1 also demonstrates that, in our sample, on average, 29% of board directors possess political capital.

Variables

RESULTS

ORECTA
Firm Size
Provincial GDP
Leverage
Profitability
Sales Growth
Blockholder Ownership
Common Blockholder
Blockholder Balance
CEO Duality
Board Independence
Board Acc/Fin Ratio
Board PC Ratio
Outside Board PC Ratio
Private
Regulated Industry
Marketization
Mean
SD

10
9
8
7
6
5
4
3
2

TABLE 1
Descriptive Statistics and Correlation Coefficients

We employed the fixed-effects regression model to


analyze the panel dataset. It is suitable for estimating
the marginal effects of explanatory variables because
it is able to control for all factors that vary across
entities but are constant over time, and for all factors
that vary over time but are constant across entities
(Wooldridge, 2002). As a result, this approach significantly alleviates potential endogeneity of explanatory variables. We also lagged all independent,
moderating (except for the marketization index noted
earlier), and control variables by one year to further
mitigate potential endogeneity.
While the use of the fixed-effects model and of
lagged independent variable alleviates concerns of
potential self-selection bias, we used a Heckman
two-stage model (Heckman, 1979) to further ensure
robustness. In other words, we hoped to rule out the
potential bias that political directors were appointed
by controlling blockholders solely to assist the latters rent misappropriation. Following Heckmans
two-stage procedure, we first estimated a probit model
to examine how the likelihood of a firm appointing
political directors or independent political directors
is affected by various firm-level and environmental
characteristics. The first-stage regressions shown in
Appendix A generated the inverse Mills ratios (the
correction for self-selection), which were in turn included alongside other variables in the second-stage
regressions.

11

Statistical Approach

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17

12

13

14

15

16

17

We also controlled for conventional firm-level


characteristics. These included Firm Size, measured
by the natural logarithm of a firms total assets; Leverage, defined as the ratio of total liabilities to total
assets; Profitability, measured by a firms operating
marginthe ratio of operating profits to sales revenues; and Sales Growth, measured by the percentage
of a firms annual increase in sales revenues. Finally,
we controlled for regional economic development by
including the natural logarithm of Provincial GDP,
disclosed by Chinas National Bureau of Statistics
each year.

1809
1.00
8.69
2.00

Sun, Hu, and Hillman

2016

1810

Academy of Management Journal

With respect to the ownership structure, the


largest blockholder on average holds 38% of a firms
total shares. The identity of the blockholders is
roughly evenly divided between private and government agencies. The small value of Blockholder
Balance implies limited checks and balances from
other blockholders. Table 1 also shows that common ownership is not prevalent: only around 10%
of the sample companies have common blockholders. Further, the variance inflation factors for
all the variables are less than 2.2, suggesting that
multicollinearity is not a concern. We also followed
Aiken and West (1991) and mean-centered both
independent variables and moderators for the interaction terms.
We performed fixed-effects hierarchical regressions to test our hypotheses, with the results shown
in Table 2. It is worth noting that these are the
second-stage estimation results that have been corrected for self-selection effects. The fact that the
estimated coefficients of Inverse Mills Ratio lack
statistical significance in all the second-stage regressions indicates the absence of self-selection bias.
Model 1 is a baseline model that includes only control variables. It demonstrates that blockholder appropriation is more serious in highly leveraged and
profitable companies. The positive estimated coefficient of Profitability suggests that, the larger the
operating profits in the previous year, the more cash
is available to be transferred from the listed firm to
its blockholder.
Tests of Hypothesis 1
Hypothesis 1 predicted a positive relationship
between board political capital and blockholder appropriation. Model 2 in Table 2 demonstrates that
ORECTA is positively and significantly associated
with both Board PC Ratio (b 5 0.015, p , .05), hence
the support for Hypothesis 1.
We also conducted analyses to shed insight into
the mechanisms leading to the enabling role of board
political capitalless regulatory oversight and more
debt financing. Legal and regulatory disciplines are
not easy to directly test because the mere appearance
of large ORECTA balances does not in itself lead to
regulatory sanctions. Sanctions can be imposed on
companies only if specific misdeeds, such as fund
diversion and book-cooking, are identified with concrete evidence. Therefore, we collected information
about all the regulatory enforcement actions on our
sample firms between 2008 and 2011 from the CSMAR
Regulatory Enforcement Research database. This

October

resulted in a total of 304 companies out of our total


sample. These problem companies were identified by regulatory agencies (CSRC and the Shanghai
and Shenzhen Stock Exchanges) to have engaged in
a variety of fraudulent activities, such as fund diversion, false information disclosure, earnings manipulation, and insider trading.
Further, we identified suspect companies in our
sample, defined as those with high ORECTA but
without regulatory agency punishment. We chose
those with ORECTA ranked in the top 20% and 10%
of the entire sample. This selection process generated 349 suspect companies at the 20% level and
104 suspect ones at the 10% level respectively.
After combining the problem and the suspect
companies, we used the count variablethe number
of enforcement actions during 20082011to measure the presence and severity of regulatory sanctions,
and used a Poisson regression model to examine the
factors that influence the severity of enforcement
actions by Chinese regulatory agencies.
Following prior literature (Correia, 2014), Table 3
shows that, whether using the top 10% or 20%
ORECTA subsample to combine with the problem
companies, board political capital measured by both
Board PC Ratio and Outside Board PC Ratio served to
reduce the number of enforcement actions. This
implies that board political capital did play a buffering role in reducing regulatory disciplines in our
sample companies.
In addition, we examined the subsample of the
problem firms only and found a strong correlation
(p , .001) between ORECTA and the number of enforcement actions on a focal firm. Firms with larger
ORECTA balances were those that had received
more enforcement actions. Moreover, the severity of
the actions was once again reduced by Board PC
Ratio and Outside Board PC Ratio, thereby suggesting that board political capital suppresses regulatory
disciplines. Due to space limits, the detailed regression results on the subsample of the problem
firms are not reported here but are available from the
authors upon request.
With regard to debt financing, we used long-term
leverage (the ratio of long-term debt to total assets)
and leverage (the ratio of total liabilities to total assets) to measure corporate access to bank financing
(Claessens et al., 2008; Faccio, 2010), with the results
shown in Table 4. We found that Board PC Ratio led
companies to have higher subsequent long-term leverage, and Outside Board PC Ratio also contributed
to higher overall leverage in the sample companies.
These findings are consistent with a large volume

0.04
6.41***

(1.02)

(0.23)
(1.91)

0.00
0.04

0.01

(0.72)

0.05

(21.36)

(21.55)

20.01

20.02

(0.41)
(0.75)
(21.47)
(2.09)
(3.00)
(23.77)
(0.31)

0.02
0.00
20.01
0.01*
0.002**
20.0002***
0.00

Model 1

(2.40)

0.02*

0.04
6.37***

(0.82)

(21.62)

(0.21)
(1.56)

(0.70)

(21.58)

(0.39)
(0.81)
(21.49)
(2.05)
(3.15)
(23.66)
(0.21)

0.01

20.02

0.00
0.03

0.05

20.01

0.02
0.00
20.01
0.01*
0.002**
20.0002***
0.00

Model 2

(20.36)
(2.30)

20.01
0.03*

0.05
5.89***

(0.33)

0.00

(0.77)

(21.66)

20.02
0.01

(0.36)
(1.49)

(0.69)

(21.57)

(0.45)
(0.78)
(21.42)
(2.05)
(3.19)
(23.55)
(0.26)

0.00
0.03

0.05

20.01

0.02
0.00
20.01
0.01*
0.002***
20.0002***
0.00

Model 3

0.05
6.13***

0.02

0.00

0.01

20.02

0.00
0.03

0.05

20.01

0.02
0.00
20.01
0.01*
0.002**
20.0002***
0.00

(1.68)

(0.44)

(0.84)

(21.56)

(0.22)
(1.58)

(0.67)

(1.57)

(0.38)
(0.88)
(21.56)
(2.09)
(3.15)
(23.60)
(0.18)

Model 4

0.05
5.80***

0.00
20.01*

0.07**

0.01

20.02

0.00
0.03

0.06

20.01

0.01
0.00
20.01
0.01*
0.002***
20.0002***
0.00

(0.86)
(21.98)

(2.52)

(0.76)

(21.69)

(0.16)
(1.45)

(0.76)

(21.62)

(0.26)
(0.73)
(21.19)
(2.00)
(3.18)
(23.75)
(0.31)

Model 5

0.05
5.55***

0.00
20.01**

0.02

20.01
0.04**

0.06*

0.01

20.02

0.00
0.03

(1.22)
(22.82)

(1.63)

(20.46)
(3.14)

(2.25)

(0.69)

(21.71)

(0.37)
(1.32)

(0.75)

(21.62)

20.01
0.06

(0.26)
(0.71)
(21.21)
(2.00)
(3.24)
(23.59)
(0.40)

0.01
0.00
20.01
0.01*
0.002***
20.0002***
0.00

Model 6

Notes: N 5 2,854. t statistics are in parentheses. Symbols , *, **, and *** denote statistical significance at 10%, 5%, 1%, and 0.1% levels respectively (two-tailed tests). The
variable Regulated Industry was omitted in Models 4 and 6 due to firm fixed-effect.

Constant
Firm Size
Provincial GDP
Leverage
Profitability
Sales Growth
Blockholder
Ownership
Common
Blockholder
Blockholder
Balance
CEO Duality
Board
Independence
Board Acc/Fin
Ratio
Inverse Mills
Ratio
Predictor
Board PC Ratio
Interactions
Private
Board PC Ratio
3 Private
Board PC Ratio
3 Regulated
Industry
Marketization
Board PC Ratio
3
Marketization
R2 (within)
F statistic

Variables

TABLE 2
Effects of Board Political Capital on Blockholder Rent Appropriation (Estimates for Heckman Second-Stage Models)

2016
Sun, Hu, and Hillman
1811

Yes
Yes
2397.69
136.06***
653

Yes
2400.92
129.60***
653

(22.52)

20.95**

Yes

(2.55)

(20.48)
(0.82)
(23.78)
(0.59)
(21.64)
(21.27)
(0.10)
(20.64)

0.46**

Yes

(2.46)

0.44**

218.68
0.82
20.28***
2.40
20.30
20.38
0.01
20.04

Model 2

Yes

(20.45)
(0.47)
(23.58)
(0.54)
(21.45)
(21.42)
(20.03)
(20.64)

217.51
0.45
20.26***
2.22
20.26
20.43
20.00
20.03

Model 1

Yes
2398.80
133.83***
653

Yes

Yes

21.69*

0.44**

216.97
0.86
20.26***
2.16
20.28
20.47
0.01
20.00

(22.01)

(2.45)

(20.44)
(0.84)
(23.58)
(0.53)
(21.50)
(21.48)
(0.07)
(20.63)

Model 3

Yes
2315.56
101.85***
408

Yes

Yes

0.23

222.85
20.32
20.25***
2.86
0.13
20.52
20.02
20.01
(1.25)

(20.57)
(20.31)
(23.45)
(0.68)
(0.56)
(21.57)
(20.20)
(21.16)

Model 4

Yes
2313.43
106.10***
408

Yes

Yes

20.81*

0.27

226.19
0.02
20.26***
3.28
0.10
20.43
20.01
20.01

(22.05)

(1.44)

(20.65)
(0.02)
(23.60)
(0.78)
(0.48)
(21.31)
(20.06)
(21.07)

Model 5

Yes
2313.22
106.53***
408

Yes

Yes

21.79*

0.23

(22.11)

(1.23)

(20.58)
(0.12)
(23.54)
(0.70)
(0.38)
(21.60)
(20.07)
(21.09)

Model 6
223.51
0.13
20.26***
2.94
0.08
20.54
20.01
20.01

Firms in the Top 10% of ORECTA

Notes: t statistics are in parentheses. Symbols , *, **, and *** denote statistical significance at 10%, 5%, 1%, and 0.1% levels respectively (two-tailed tests).

Constant
ORECTA
Firm Size
Provincial GDP
Leverage
Profitability
Sales Growth
Blockholder
Ownership
Private
Predictors
Board PC Ratio
Outside Board
PC Ratio
Industry
dummies
Provincial
dummies
Year dummies
Log-likelihood
x2
Observations

Variables

Firms in the Top 20% of ORECTA

TABLE 3
Poisson Regressions Examining the Effects of Board Political Capital on the Severity of Regulatory Sanctions

1812
Academy of Management Journal
October

2016

Sun, Hu, and Hillman

TABLE 4
Effects of Board Political Capital on Corporate Debt
Financing
Variables
Constant
Firm Size
Provincial
GDP
Profitability
Sales Growth
Blockholder
Ownership
Private
Board Size
Predictors
Board PC
Ratio
Outside
Board PC
Ratio
Industry
dummies
Provincial
dummies
Year
dummies
R2
F statistics

Long-Term Leverage
as Dependent Variable

Leverage as
Dependent Variable

20.45***
0.03***
20.02***

(210.39)
(18.48)
(26.23)

0.26
0.02*
20.02

(21.54)
(2.27)
(21.61)

20.00
20.00
20.0003**

(20.30)
(20.13)
(22.28)

0.01**
0.00
20.002***

(23.17)
(0.58)
(23.81)

0.01
20.00

(1.40)
(21.68)

20.02
0.00

(21.11)
(20.94)

0.02*

(2.05)
0.22**

Yes

Yes

Yes

Yes

Yes

Yes

0.35
67.15***

0.04
4.44***

(2.65)

Notes: N 5 2,854. t statistics are in parentheses. Symbols , *, **,


and *** denote statistical significance at 10%, 5%, 1%, and 0.1%
levels respectively (two-tailed tests).

of literature documenting the positive role of


political connections in securing debt financing
(e.g., Claessens et al., 2008; Li et al., 2008).
Tests of Hypotheses 24
To test the hypothesized moderating effects, we
added the interaction terms between board political
capital and the three moderating variables, blockholder identity, industry regulation, and subnational
institutional environments, to the respective models
in Table 2. Models 35 in Table 2 show the interaction
effects and Model 6 is the full model.
Hypothesis 2 posited that the effect of board political capital on appropriation is more pronounced
in companies controlled by private entities. With
Private as a moderator, a significantly positive interaction effect is found for Board PC Ratio and Private in Model 3 (b 5 0.03, p , .05) and Model 6 (b 5
0.04, p , .01). Hence, Hypothesis 2 is supported.
Hypothesis 3 postulated that the positive association between board political capital and blockholder

1813

appropriation is more pronounced in heavily regulated industries. The interaction effect of Board PC
Ratio and Regulated Industry on ORECTA is positive
but marginally significant in Model 4 (b 5 0.02,
p , .10) and Model 6 (b 5 0.02, p , .10). Therefore,
we only receive qualified empirical support for
Hypothesis 3.
Hypothesis 4 predicted that the positive association between board political capital and blockholder
appropriation is less pronounced in firms residing
in regions with more-developed institutions. Using
Marketization as a moderator, Model 5 shows a significantly negative interaction effect of Board PC
Ratio and Marketization (b 5 20.01 p , .05). Similarly, the full Model 6 demonstrates a similar negative effect (b 5 20.01, p , .01). Results in both
models provide strong support for Hypothesis 4. To
shed further light on these moderating relationships,
we followed Aiken and West (1991) to plot the twoway interaction effects of Board PC Ratio and the
three moderating variables as illustrated in Figure 1.
Outside Board Political Capital as a Robustness
Check
While Board PC Ratio was used to measure political
capital of an entire board, we also used political capital embedded in independent directorsmeasured
by Outside Board PC Ratioas another explanatory
variable to test our hypotheses. Table 5 reports the
second-stage estimation results with the same model
specification. The estimations generate very similar
findings to those in Table 2, thus offering further
support for our hypotheses. These findings lend credence to our argument that political capital embedded in co-opted outside directors can harm the
interests of minority investors by heightening blockholder opportunism.
Implications for Firm Performance
While minority shareholders suffer blockholder
rent appropriation, one may wonder whether this
activity is necessarily bad for the whole firm. Similarly, if board political capital increases blockholder
opportunism, will this dark side of political capital
ultimately affect firm performance? Our supplementary analysis in Table 6 helps answer these
questions. First, we followed Jiang et al. (2010) to
study the performance consequence of ORECTA.
Using return on assets (ROA) and Profitability (operating profits divided by sales revenues) to measure
firm performance, we show in Models 1 and 4 that

1814

Academy of Management Journal

October

.015

Private

Low
High
The percentage of directors with political capital

.01

State

Non-regulated industries

Regulated industries

Low
High
The percentage of directors with political capital

ORECTA
.01
.02

.03

.01

.02

ORECTA
.03

ORECTA
.02
.025

.04

.03

FIGURE 1
Moderating Effects of Blockholder Identity, Industry Regulation, and Subnational Institutional Environment

Low level of marketization


High level of marketization

Low
High
The percentage of directors with political capital

ORECTA in year t 2 1 has a strong negative impact


on firm performance in the following year (t). This
finding suggests that blockholder rent appropriation
is not only detrimental to small shareholders but also
jeopardizes firm performance.
Second, none of the models in Table 6 finds a significant association between board political capital
and firm performance. This result is inconsistent with
the conventional resource dependence logic, but is in
line with our prediction: board political ties may not
lead to better performance precisely because they
have a dark side, as indicated in our study.
DISCUSSION AND CONCLUSION
Placing political actors on boards is an important
corporate political strategy. In this paper, we caution

against the conventional resource dependence logic


by demonstrating that board political capital can
have its dark side. The very capital embedded in
board-political linkages can be leveraged by the
blockholders to enhance their power advantages
over small shareholders, thus inviting more blockholder opportunism. Our empirical findings support the arguments and show that board political
capital facilitates blockholder rent appropriation in
China. This facilitating effect is found to be more
salient in firms whose controlling blockholders are
private entities, in firms operating in heavily regulated industries, and in those located in institutionally less-developed provinces.
However, these findings should not be interpreted
as a conspiracy between blockholders and political
directors against minority shareholders. Nor do we

(2.67)

0.04**

0.05
6.48***

(0.29)
(0.87)
(21.45)
(2.08)
(3.00)
(23.65)
(0.25)
(21.64)
(0.73)
(0.28)
(1.62)
(21.71)
(1.02)

0.01
0.00
20.01
0.01*
0.002**
20.0002***
0.00
20.01
0.05
0.00
0.03
20.02
0.01

Model 1

(20.09)
(2.05)

20.00
0.06*

0.05
5.90***

(0.58)

(0.24)
(0.87)
(21.39)
(2.09)
(2.99)
(23.56)
(0.32)
(21.60)
(0.68)
(0.38)
(1.57)
(21.73)
(1.03)

0.01

0.01
0.00
20.01
0.01*
0.002**
20.0002***
0.00
20.01
0.05
0.00
0.03
20.02
0.01

Model 2

0.05
6.22***

0.04

0.01

0.01
0.00
20.01
0.01*
0.002**
20.0002***
0.00
20.01
0.06
0.00
0.03
20.02
0.01

(1.65)

(0.51)

(0.28)
(0.99)
(21.57)
(2.07)
(3.07)
(23.59)
(0.26)
(21.61)
(0.75)
(0.32)
(1.60)
(21.63)
(0.95)

Model 3

0.00
20.01
0.05
5.76***

0.11*

0.02
0.00
20.01
0.01*
0.002**
20.0002***
0.00
20.01
0.06
0.00
0.03
20.02
0.01

(0.48)
(21.45)

(2.06)

(0.31)
(0.84)
(21.18)
(2.07)
(3.04)
(23.74)
(0.32)
(21.65)
(0.76)
(0.24)
(1.55)
(21.76)
(0.95)

Model 4

0.00
20.01*
0.05
5.39***

20.00
0.08**
0.05

0.08

0.02
0.00
20.01
0.01*
0.002**
20.0002***
0.00
20.01
0.05
0.00
0.03
20.02
0.01

(0.70)
(22.01)

(20.16)
(2.79)
(1.90)

(1.40)

(0.29)
(0.98)
(21.31)
(2.07)
(3.14)
(23.60)
(0.45)
(21.57)
(0.72)
(0.42)
(1.43)
(21.72)
(0.86)

Model 5

Notes: N 5 2,854. t statistics are in parentheses. Symbols , *, **, and *** denote statistical significance at 10%, 5%, 1%, and 0.1% levels respectively (two-tailed tests).

Constant
Firm Size
Provincial GDP
Leverage
Profitability
Sales Growth
Blockholder Ownership
Common Blockholder
Blockholder Balance
CEO Duality
Board Independence
Board Acc/Fin Ratio
Inverse Mills Ratio
Predictor
Outside Board PC Ratio
Interactions
Private
Outside Board PC Ratio 3 Private
Outside Board PC Ratio 3 Regulated
Industry
Marketization
Outside Board PC Ratio 3 Marketization
R2 (within)
F statistics

Variables

TABLE 5
Effects of Outside Board Political Capital on Blockholder Appropriation (Estimates of Heckman Second-Stage Models)

2016
Sun, Hu, and Hillman
1815

0.11
0.26
62.29***
0.26
62.26***

(0.17)
0.26
53.32***

0.02
(22.58)
(0.21)
21.30**
0.03
(20.87)

20.09
0.14
58.29***
0.16
58.23***

0.13
58.12***

(20.18)
20.01
(27.14)
(20.14)
21.15***
20.01

Notes: N 5 2,854. t statistics are in parentheses. Symbols *, **, and *** denote statistical significance at 5%, 1%, and 0.1% levels respectively (two-tailed tests).

(0.40)

(5.44)
(26.23)
(17.09)
(21.04)
(20.08)
5.51***
20.30***
2.17***
20.00
20.04
(5.45)
(26.24)
(17.07)
(21.03)
(20.11)
5.52***
20.30***
2.17***
20.00
20.05
(5.59)
(26.36)
(17.23)
(21.14)
(20.09)
5.65***
20.30***
2.19***
20.00
20.04
(1.26)
(22.34)
(17.02)
(0.99)
(20.54)
0.41
20.03*
0.79***
0.00
20.12
(1.19)
(22.30)
(17.01)
(0.99)
(20.50)
0.38
20.03*
0.79***
0.00
20.11
(1.94)
(22.95)
(16.43)
(0.74)
(20.46)
0.62*
20.04**
0.75***
0.00
20.10

Constant
Firm Size
Leverage
Blockholder Ownership
Private
Predictors
ORECTA
Board PC Ratio
Outside Board PC Ratio
R2 (within)
F statistics

Model 6
Model 5
Model 4
Model 2
Model 1
Variables

Panel A: ROA as Dependent Variable

Model 3

Panel B: Profitability as Dependent Variable

Academy of Management Journal

TABLE 6
Supplementary Analysis: Effects of Blockholder Appropriation and Board Political Capital on Subsequent Firm Performance

1816

October

suggest that political directors are appointed by


blockholders simply to assist their appropriation of
firm wealth. Rather, they are invited on boards primarily to help generate rents for focal companies. An
unintended consequence of these cooptive linkages,
however, is the creation of a shield for blockholders
against disciplinary forces in the legal/regulatory
and market-based mechanisms.
Regarding firm performance implications, a straightforward application of resource dependence theory
would likely predict a strong positive performance
effect of board political capital. However, our integration between resource dependence and
agency perspectives shows how and why the dark
side of board political capital can negate the beneficial effect. Different from most extant studies,
we obtain a direct measure of principalprincipal
agency conflicts and provide direct evidence
of how board political capital aggravates such
conflicts.
Theoretical Contributions
Both agency and resource dependence theories are
primary perspectives to understand the functioning
of corporate boards, though neither of them portrays
a complete picture of how boards work in reality.
Despite the conceptual work by Hillman and Dalziel
(2003), only a small number of ensuing empirical
studies have integrated the two perspectives in the
context of board research. They focused on the synergy between board capital from the resource dependence lens and board incentives couched in
agency terms in reducing managerial agency conflicts (Feldman & Montgomery, 2015; Kroll et al.,
2008; Tian et al., 2011). An underlying assumption is
that board capital can mitigate agency problems.
Our paper instead implies another direction for
this theoretical integration by highlighting the potential tension between board capital and the management of agency conflicts (Zona, Gomez-Mejia, &
Withers, 2015). Concentrating on political capital
and blockholder opportunism, we unravel the
mechanisms through which board political capital
exacerbates principalprincipal agency conflicts.
Consequently, this integration generates substantive
contributions to both resource dependence and
agency theories.
Our study advances resource dependence theory
by improving our understanding of the strange
omission queried by Pfeffer (Pfeffer & Salancik,
2003: xix)the conditions under which cooptation
strategies for enhancing organizational performance

2016

Sun, Hu, and Hillman

can be effective. Both resource dependence and


agency theories can be treated as theories of firm
performance, but with different focuses. Whereas the
former focuses on rent creation through the provision of external resources by cooptive linkages,
the latter concerns rent appropriation by economic
agents. This difference implies that addressing the
question of resource provision for whom from
the agency theory perspective may be a fruitful
avenue through which to enrich resource dependence
theory.
Moreover, both are theories about power. While
resource dependence literature has long recognized
that external interdependence can shape power relationships inside an organization (Hillman et al.,
2009; Pfeffer & Salancik, 2003), it remains largely
silent on if and how internal power dynamics impact
agency conflicts. Similarly, although past research
has recognized the role of human and social capital
in rent capture within firms (Blyler & Coff, 2003;
Carpenter, Sanders, & Gregersen, 2001), it falls short
of identifying the impact of such capital on agency
conflicts that may in turn affect rent allocation outcomes. Our study takes a step forward by inspiring
future research to examine the complex interplay
among board capital, power relations, and agency
conflicts in varying contexts.
Our study advances agency theory by enriching
our knowledge of whether and how boards matter
for the management of principalprincipal agency
conflicts. According to the scant literature in this
regard (Peng, 2004; Young, Ahlstrom, Bruton, &
Chan, 2001), boards (even their independent directors) in economies featuring principalprincipal
agency conflicts play a very limited role in monitoring blockholders and management. Young and
colleagues (2008: 200) asserted that blockholders
effective control over director selection nullifies
a boards ability to oversee controlling shareholders.
Instead, boards in this context have been perceived
as serving an important resource provision function.
We contend that boards do matter for the management of principalprincipal agency conflicts. Future
research can examine if and how other types of
capital embedded in boards also impact blockholder
rent appropriation. Doing so will add to our limited
understanding of organizational-level antecedents
to the principalprincipal agency conflicts.
In addition, our paper contributes to corporate
political strategy literature by joining an emerging
body of research on the contingent value of corporate
political capital. Prior consensus in this literature is
that political strategies generally enhance firm

1817

performance (Hillman et al., 2004, 2009). However,


rents generated by corporate political capital may
evaporate under a variety of circumstances, including sudden changes in the political landscape
(Siegel, 2007; Sun, Mellahi, Wright, & Xu, 2015),
changes in the business environment (Sun, Mellahi,
& Thun, 2010), and surplus extraction by political
actors and institutions (Kivleniece & Quelin, 2012;
Okhmatovskiy, 2010).
Our analysis demonstrates how multi-theoretic
integration can guide future research on the effectiveness of corporate political strategies (Mellahi
et al., 2016). Theories focusing on rent creation
mechanisms, such as resource dependence, can be
integrated with theories emphasizing rent appropriation (e.g., agency theory) to better understand
the conditions under which the dark side of a certain corporate political strategy may come about.
While some prior studies postulate that agency
theory might explain the lack of a relationship between political strategy and firm performance
(e.g., Hadani & Schuler, 2013), we identify specific
mechanisms through which corporate political
capital can aggravate existing agency problems.
Practical and Policy Implications
Our research findings pose a delicate question
to outside investors, who normally value political
connections (Faccio, 2006; Hillman et al., 1999): To
the extent that board political capital has the potential to destroy firm value by facilitating blockholder
appropriation, how should they weigh the purported
benefits against the potential costs? Although our
study cannot provide a clear-cut answer, it does
recommend that investors pay attention to a firms
relevant organizational and environmental contingencies: the negative effect can be greater when the
focal company lacks political connections via other
channels such as government ownership stakes,
but can be smaller in a less regulated industry or in
a more developed institutional environment.
As for blockholders, this study does not imply that
they are necessarily opportunistic. It is unlikely that
they appoint directors with political background simply for self-enrichment; rather, they need them to help
create rents through the political process. Therefore,
blockholders may find it in their own interests to signal
to the outside community that they will refrain from
exploiting board political capital for private gain.
Our research also has relevance to policymakers.
As corporate political ties are prevalent around the
world (Lester et al., 2008; Sun et al., 2012), it may

1818

Academy of Management Journal

neither be feasible nor desirable to prevent political


actors from taking board positions in publicly traded
corporations. In fact, the human and social capital
provided by political directors can be beneficial
to the whole firm unless such capital is employed
by one party to take advantage of other corporate
stakeholders. Such a perverse effect takes place
through institutions that cause legal, regulatory, and
market mechanisms to be susceptible to political influences. If policy reforms can reduce the roles of
political actors in buffering legal and regulatory
disciplines and securing favorable policy resources,
board political capital may be channeled toward
more value creation activities.
Generalizability, Limitations, and Future Research
Our research findings are based on an empirical
analysis of Chinese listed companies, so we must
exercise caution in extrapolating these results to
other contexts. Specifically, our theory development is based on two contextual conditions. First,
the blockholder opportunism arises from concentrated ownership and largely passive boards captured by a single blockholder group. Second, weak
institutions allow board political capital to help
insulate blockholders from legal, regulatory, and
market disciplines. Therefore, it is important to assess the generalizability of our research when the
two contextual conditions are not met.
Regarding the first condition, little is known
about whether board capital might also exacerbate
managerial agency problem in widely held public
corporations. Provided that the management could
somehow leverage board capital to enhance their
executive power advantage over dispersed shareholders (Joseph, Ocasio, & McDonnell, 2014), is
board capital always a blessing for shareholders?
Moving into this largely uncharted territory may
prove crucial in establishing the generalizability
and limits of our present study.
With respect to the second condition, future research can examine how far board political capital
can increase blockholder opportunism in developed
economies with more robust institutional infrastructures. For example, the corporate sector in
continental Europe is characterized by concentrated ownership structures (Desender et al., 2013).
Even in the United States, recent studies suggest
that large blockholders in its publicly traded firms
are by no means rare (Anderson & Reeb, 2004). Does
board political capital similarly help management buffer legal/regulatory disciplines in developed

October

economies featuring more robust institutions and


board independence, or will it instead receive more
scrutiny from the regulator or the public? Future research on this front could also cast light on the generalizability of our theoretical claims.
On the empirical front, our paper is not without
limitations either. First, while ORECTA is a very
easily observed form of blockholder rent appropriation, a caveat is important: we cannot say that rent
appropriation is not occurring within firms through
other, less transparent means. Particularly, we cannot preclude the possibility that those without board
political capital will elect to divert firm wealth in
more secretive forms. So, future research that can
develop ingenious ways of ferreting out sneakier
forms of rent appropriation will be useful in checking the robustness of our findings.
Second, we adopted the conventional measure
Board PC Ratioto estimate the stock of board political capital. While this dichotomous, additive
approach has been widely used in prior research on
political connections (Faccio, 2006; Hillman, 2005)
and on boards human and social capital (Johnson,
Schnatterly, & Hill, 2013), we acknowledge that this
approach neglects the heterogeneity of political capital. We are not able to obtain detailed information
about individual bureaucratic ranks and years of service in government/legislative agencies from directors
biographical sketches. Thus, future research can improve the precision of our empirical analysis by collecting more granular data at the director level.
Third, while the paper has documented the effects
of board political capital on regulatory sanctions and
corporate debt financing, we acknowledge that they
can only serve as indirect support of the underlying
mechanisms leading to our first hypothesis. With
respect to the legal/regulatory mechanism, we lack
detailed data in the legal system, and some of the
targets of regulatory sanctions in our dataset, such as
insider trading, are not directly related to blockholder misappropriation of cash flows. Regarding
the market-based mechanism, future research can
improve the rigor of our research by collecting and
analyzing more data for longer periods to trace the
longitudinal co-movement patterns between firms
equity and debt financing activities.
In closing, we believe this piece of work represents
the end of a beginning: while it accomplishes a
detailed analysis of how board political capital can
become a liability for Chinese firms by enabling
blockholder rent appropriation, it also heralds opportunities for integrating resource dependence and
agency theories to study how board capital interacts

2016

Sun, Hu, and Hillman

1819

with various corporate stakeholders for rent creation and appropriation across different institutional
contexts.

China Securities Journal. 2012, April 11. Large shareholders


occupy RMB 3.4 billion from 60 listed companies. China
Securities Journal. Available at http://www.cs.com.cn/
ssgs/gsxw/201204/t20120411_3312606.html. Accessed
December 19, 2014.

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October

APPENDIX A

TABLE A1
Determinants of Having a Politically Connected Board
(Probit Estimates of Heckman First-Stage Models)
Board Political
Capital
Constant
ORECTA
Firm Size
Leverage
Profitability
Sales Growth
Blockholder
Ownership
CEO Duality
Board
Independence
Board Size
Private
Industry
dummies
Province
dummies
Year dummies
Wald x

Outside Board
Political Capital
20.66
20.28
20.04
0.03
20.33*
20.01
20.00

0.79
0.16
20.10**
0.27*
20.04
0.08
0.00

(1.17)
(0.20)
(23.28)
(2.26)
(20.43)
(1.38)
(0.71)

20.13
1.31*

(21.40)
(2.01)

0.07
1.89**

(0.83)
(2.96)

(6.09)
(0.61)
Yes

0.07***
0.09
Yes

(3.88)
(1.35)
Yes

0.12***
0.04
Yes

(21.06)
(20.36)
(21.28)
(0.29)
(22.23)
(20.63)
(20.31)

Yes

Yes

Yes

Yes

Yes
255.38***

Yes

Yes
107.81***

Yes

Notes: N 5 2,854. t statistics are in parentheses. Asterisks *, **,


and *** denote statistical significance at 5%, 1%, and 0.1% levels
respectively (two-tailed tests).