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Journal of Business Ethics

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16-10-2014

Social Capital, Informal Governance, and Post-IPO Firm Performance: A Study of Chinese Entrepreneurial Firms

Authors: Jerry X. Cao, Yuan Ding, Hua Zhang

Published in: Journal of Business Ethics | Issue 4/2016

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Abstract

Social capital can serve as informal governance in weak investor-protection regimes. Using hand-collected data on entrepreneurs’ political connections and firm ownership, we construct several original measures of social capital and examine their effect on the performance of entrepreneurial firms in China after their initial public offerings. Political connections or a high percentage of external investors tend to enhance firm performance, but intragroup related-party transactions commonly lead to performance decline. These forms of social capital have a strong influence on the performance of Chinese firms, whereas formal governance variables such as board size or board independence have little effect. Although social capital may serve as an informal governance mechanism and effectively substitute for formal governance mechanisms in an emerging market, this role of social capital raises several ethical concerns, notably the development of rent-seeking and crony capitalism.

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In contrast to the agency problem known to exist when ownership is diffused, the main conflict in China is between controlling and minority shareholders, because the controlling shareholders have highly concentrated ownership (Shleifer and Vishny 1997). According to Bae et al. (2012), controlling shareholders’ expropriation of minority shareholder investments is the key channel through which corporate governance affects firm value.

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Khanna and Palepu (2000) explain that when institutions intended to enhance the efficiency of input and output markets are underdeveloped, family firms and business groups can act as substitutes for the inefficient external capital and labor markets.

‘Mainland stocks become world giants after defying global rout’, South China Morning Post, August 15, 2007, p. B20.

As the Chinese stock market was not doing well during the period 2002–2006, the whole process took four or even 5 years for some firms in our sample.

For details, see the literature review by Ritter and Welch (2002, p. 1796) and the CFO survey by Brau and Fawcett (2006).

In Chinese entrepreneurial companies, most founders are actively involved in the management of their firms. Of the 82 sample companies that have political bridging social capital, there are only five in which the founding entrepreneurs do not occupy any management position. Even for these five firms, it could be argued that the firms still reflect the entrepreneur’s efforts to build political bridging social capital by engaging managers with such social capital.

Tian et al. (2008) present a comprehensive study on how Chinese private entrepreneurs participate in politics.

The application of year fixed effects is very necessary, since our sample period includes the Split Share Structure Reform period in China between 2005 and 2006, which terminated trading constraints on restricted shares in China and also threatened the price premium on their freely traded counterparts. The literature documents that this reform brought about profound changes in the power balance between large and small shareholders, as well as in large shareholders’ incentives vis-à-vis the firm’s accounting and market performances (Hou and Lee 2013; Cumming and Hou 2014).

Of these 32 firms, eight had political bridging social capital prior to their IPO.

When both the pre- and post-IPO connections are loaded in Column 5, the significance bounces back.

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Title: Social Capital, Informal Governance, and Post-IPO Firm Performance: A Study of Chinese Entrepreneurial Firms
Authors: Jerry X. Cao
Yuan Ding
Hua Zhang
Publication date: 16-10-2014
Publisher: Springer Netherlands
Published in: Journal of Business Ethics / Issue 4/2016
Print ISSN: 0167-4544
Electronic ISSN: 1573-0697
DOI: https://doi.org/10.1007/s10551-014-2383-5

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