Corporate Finance and Government-Corporations Linkages
Open AccessCorporations and government are two important players in an economy and depend on each other on various issues. On one hand, the business activities in the corporate sector have a direct effect on the economy and thus have an impact on the decisions of the policy makers and regulators. Also, corporations work with government as suppliers where they obtain contracts from federal and state government and deliver products and services which enable government to pursue its operations. On the other hand, changes in the government policies and regulations may have a direct effect on how corporations operate such as changing procurement laws, changes in fiscal and monetary policy, institutional changes or banking, securities and investment regulations. The dynamic relation between government and corporations, thus give rise to important questions in corporate finance. In this dissertation, we focus on two of these important issues, one is domestic and one is international. In the first chapter, we look at anti-corruption campaign in China and how it affected real investment in different provinces with varying institutional characteristics. In the second chapter, we look at how fiscal policy changes affected procurement and thus the effort the corporations put in developing relations with the government through lobbying using U.S. data . While examining these issues, we employ unexpected shocks to alleviate endogeneity issues that arise while examining government corporation linkages. Chapter 1 “Institutional Quality and Corporate Investment: Evidence from Anti-Corruption Campaign in China” examines the effect of anti-corruption reforms on corporate investment in relation to institutional quality by exploiting the unanticipated nationwide anti-corruption campaign targeting senior provincial government officials between 2012 and 2016 in China. Anti-corruption reforms could improve the business environment and increase economic efficiency so as to facilitate private sector development. However, anti-corruption reforms could also break the existing government connection network and create uncertainty for firms with close connections to the government. Therefore, how firms change their investment in response to the anti-corruption reforms is an open empirical question. We find that firms in general increase their investment after anti-corruption investigations and the increase of investment is driven by domestic private firms instead of state-owned enterprises or foreign firms. By using seven measures of institutional quality, we find that domestic private firms increase their investment only in provinces with existing high-quality institutions while firms in provinces with existing low-quality institutions do not show such an effect. Provinces with high-quality institutions have a higher level of market development and a more vibrant private sector such that business owners are able to get government approval in a timely and transparent manner. These provinces also have stronger intermediary organizations such as law firms and accounting firms to protect property rights. Overall, the baseline findings support the notion that when existing institutions function well, improving governance in government through anti-corruption campaigns increase real investment in the corporate sector. Thus, improved governance has a positive effect on real investment in such an environment and the uncertainty of breaking existing links with government do not overshadow this effect. We next measure a firm’s government connection by using prior dependence on government subsidy or government financing as a proxy. We utilize the notion that firms have to establish good relationship with the government in order to get subsidy or financing from government in China. We study if firms with higher prior government dependence or financial dependence are more adversely affected by the anti-corruption reforms. We find that state-owned enterprises (SOEs) with higher government dependence or financial dependence significantly reduce their investment after the anti-corruption reforms. We further show that the reduction in investment by SOEs is only observed in provinces with low-quality institutions. Our findings point out that institutional quality is a key factor that affects the impact of governance reforms on the real economy. The positive effect of improved business environment dominates the adverse effect of severing existing ties with government when existing institutions function well. Therefore, firms increase their investment. In provinces with low-quality institutions, on the other hand, firms are more likely to get preferential treatment if they have close connections to the government and therefore severing ties with existing government officials are costly. Thus, when anti-corruption reforms break such connections, firms reduce their investment.Our statistical significant findings in Chapter 1 translate into meaningful economic consequences on real investment at the firm level. After the anti-corruption reforms, domestic private firms in high-quality institutions increase investment by up to $10.2 million (or 1.46% as a fraction of total assets) while state-owned enterprises with close government connections reduce investment by up to $34.2 million (or 1.85% as a fraction of total assets). Besides our main findings, we offer several supplementary findings support the conclusions. At first, we find that state-owned enterprises with close government connections reduce even more investment with subsequent anti-corruption investigations, showing that more investigations poise greater shock to existing connections and create more political uncertainty/instability. Also, anti-corruption reforms increase the investment-q sensitivity for private firms especially the domestic ones, indicating that private firms with more growth opportunities could more efficiently transfer their choices into real investment after the reforms. In addition, we find similar results when we relate to riskiness of the shadow banking system compared to when we relate to institutional quality, as private firms increase investment in provinces with lower risk and state-owned enterprises with close government connections reduce investment in provinces with higher risk. The evidence shows that institutional quality is priced in the riskiness of the shadow banking system (Chengtou bond) at the province level as most of provinces with high risk have low-quality institutions. Finally, we find the similar anti-corruption investigations in 2007-2011 work very differently compared to the nationwide campaign in 2012-2016 which is somewhat unexpected combined with the event study results in the existing literature.Chapter 2 “Doing More for Less? New Evidence on Lobbying and Government Contracts” exploits the unanticipated US Sequestration of federal budget accounts in March 2013 that automatically reduced the availability of government funds disbursed through procurement contracts, and examine how contractors adjusted their lobbying activities in response. Firms may lobby to convey valuable information to policy makers who can then make more informed decisions for the public interests. However, firms may also lobby to get preferential treatment from the government in order to get more benefits for themselves, sometime at the expense of others. In this chapter, we try to disentangle the two effects and show evidence that is consistent with the rent seeking motivation in this specific setting. Our findings suggest that firms with different degrees of exposure to the Sequestration exhibit a considerable variation in their lobbying expenditures after the event. While firms with no or less exposure to the sequester cut reduce their lobbying expenditures after the event, firms with more exposure to the cut significantly increase their lobbying spending after the event. This finding is robust to alternative specifications, a matching exercise based on 1-to-3 nearest neighbor matching on propensity score and two placebo tests. The estimation results in our baseline specification are not only statistically but also economically significant. Firms with low exposure to the Sequestration event cut their lobbying expenditures by 3.1 percent but firms with high exposure to the event increase their lobbying expenditures by 3.3 percent. This finding is consistent with the rent-seeking hypothesis since firms which are more affected by the event lobby more to get preferential treatment and receive a larger share from a smaller pie or simply keep their existing market share. Since Sequestration event is predetermined but unexpected and the budget cut is conducted according to a publicly available formula, it’s hard to convince the audience with an information explanation. If firms increase their lobbying spending to better informed the policy makers and regulators so as to protect the public interests, firms with more exposure of being sequestered should not lobby more compared to firms with less exposure even though the two groups of firms have similar pre-event total contract amounts, lobbying amounts and size and operate in the same industries. Besides the main findings, we offer several supplementary findings that support a rent-seeking explanation. If firms which are more sequestered lobby more to extract rents, then the effect should be stronger with more intense competition. By measuring competition at the firm, industry and agency levels, we show that the increase of lobbying expenditures by more sequestered firms is driven by the samples of firms facing high competition. We also show similar evidence through government dependence. If firms are operated in industries with a higher level of government spending exposure, then the increase of lobbying for sequestered firms will be intensified given that their industries are more government-dependent. In addition, we do find evidence that sequestered firms with the most increase in lobbying spending are able to procure more contracts compared to sequestered firms with the least increase in lobbying spending. However, the increase of lobbying spending does not seem to trigger higher operating performance. If the objective of lobbying is to convey valuable information to the policy makers, the delivery of such information should have increased the firm’s performance. We also look at counterfactual operating performance to see if firms are better off assuming they do not spend on lobbying activities at all. We don’t find such supporting evidence. Furthermore, we find that sequestered firms shift their lobbying efforts toward federal agencies instead of Congress while non-sequestered firms do not seem to switch. Since federal agencies have the discretionary rights to choose the contractors to work with and Congress is in charge of a more general matter like regulation passage, such evidence points towards that sequestered firms shift their lobbying efforts to get preferential treatment from federal agencies. In addition, lobbying by individual firms relative to lobbying by industry associations have increased after the Sequestration event, which provides another piece of evidence supporting the rent seeking motivation. While industry associations are more likely to lobby as a group for delivering industry-level information to policy makers to benefit all, individual firms are more likely to lobby to extract private benefits for themselves. Therefore, the findings are in line with the rent seeking explanation. The findings in Chapter 2 is consistent with the rent-seeking interpretation of why firms with higher exposure to the Sequestration event increase their lobbying expenditures after the event, compared to firms with lower exposure. Although we cannot rule out the information-based explanation and firms may still deliver publicly unknown but important information to the policy makers, we can at least show evidence in line with the rent seeking motivation of lobbying activities.Taken as a whole, the first essay demonstrates how firms’ investment following the anti-corruption reforms depend on existing institutional quality. Following anti-corruption reforms, private firms increase their investment in provinces with high-quality institutions while state-owned enterprises with higher prior government dependence or financial dependence reduce their investment in provinces with low-quality institutions. The second essay shows that firms significantly increase their lobbying expenditures after an exogenous shock to government spending that reduces overall pie of government contracts, more consistent with the rent seeking explanation of the lobbying activities.
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