Appendix A.Construction of the Index of Political Connections: the PC Index

Online Appendix of “Political connections, market frictions, and financial constraints: Evidence from China” by Kebin Deng, HaijianZheng, and Yushu Zhu.

Appendix A.Construction of the index of political connections: the PC index

We assign a score to each member of a company’s board and its senior managers, and aggregate all scores at the firmlevel each year. The political scoreswere assigned according to the following rules.

Rule 1: For individuals who had ever been a government official during the study period 2001 to 2011, scores (in parentheses) were assigned according to the level of the role:Vice-Ministerial Officer and above (7); Departmental Officer (6); Deputy DepartmentalOfficer (5); Divisional Administrator(4);Divisional Vice-Administrator (3); Section Chief (2); Vice-Section Chief and below (1).
Rule 2: For individuals who had ever been a member of the NPC(National People’s Congress) or CPPCC (Chinese People’s Political Consultative Conference)scores (in parentheses) were assigned according to the level of the membership: Memberof the National People's Congress (6);Memberof the ProvincialPeople'sCongress (4); Memberof the Municipal People's Congress (2).
Rule 3: For individuals with a variety of government department positions or NPC/CPPCC memberships, we select the highest score.
Rule 4: If the firm is part of a state-owned entity, we add 40 to the score. For robustness, we replaced this with 30, 20, and 10in our unreported results. The results are similar tothosereported in this paper.

Cadre-level divisions in China are as follows(excluding Party Committee, NPC, and CPPCC):

1. National-levelcadres:

Premier of the State Council (first stage);
Vice-Premier of the State Council (second stage);
Member of Standing Committee of the State Council (third stage).

2. Provincial-level cadres (Ministerial):

State Council Ministerial cadre, such as Minister of Education, Director of the National Development and Reform Commission;
Government cadres at Provincial and Municipal level, and levels directly controlled by a Municipality, such as Governor of Jiangsu Province,Mayor of Tianjin;
Army cadres, such as Military Commander of Jiangsu Province, Army Commander of 12th Military Region.

3. Provincial deputy-level cadres (Deputy Ministerial):

State Council Deputy Ministerialcadre, such as Deputy Director of the Municipal People's Congress and Deputy Director of the General Administration of Sport of China;
National Bureau cadres under the administration of State Council Ministries and Commissions;
Deputy Government cadres at Provincial and Municipal level, and levels directly controlled by a Municipality, such as Vice-Governor of Anhui Province, Vice-Mayor of Chongqing;
Deputy Provincial government cadres, such as Mayor of Nanjing city;
Army Deputy cadres, such as Deputy Commander of Garrison Command in Zhejiang Province, Vice-Captains of 31stMilitary Region.

4. Departmental-level cadres (City):

Ministerial and Commissioncadres under the State Council Department, such as the Ministry of Education, Director-General of the Department of Social Science Research and Ideological and Political Work;
The Provinces, Autonomous Regions and Municipalities directly under Central Government Bureaucadres, such as Hebei Transportation Bureau Director and Beijing Municipal Finance Bureau Chief;
The Deputy Provincial and Municipal government deputy cadres, such as Vice-Mayor of Ningbo city, and Prefectural government cadres, such as Wuxi City Mayor;
Divisional Army cadre, such as the First Troop General Secretary.

5. Deputy Departmental-level cadres:

Department Deputy cadres of Ministries and Commissions of the State Council, such as the Deputy Director of the Ministry of Personnel Flow of Talent Development Division;
Department Deputy cadres of Provinces, Autonomous Regions, and direct-controlled Municipalities, such as Deputy Director of the Bureau of Construction in Heilongjiang Province, Deputy Director of Shanghai Municipal Bureau of Culture;
Government Bureau and District cadres in Deputy Provincial cities, such as Director of Education Bureau of Nanjing city and the Warden of Jiangning District;
The City Government Deputy cadres, such as Vice-Mayor of Suzhou City.
Deputy Divisionaltroopcadres, such as the 35th Division Deputy Political Commissar, the Brigadier of 179th Brigade.

6. Administrator of division-level cadres(County):

Cadres of the offices of Ministries and Commissions of the State Council Department, such as the Ministry of Agriculture Planting Industry Management Department Director of Economic Crops;
Cadres of Provinces, Autonomous Regions and direct-controlled Municipalities Offices, such as Science and Technology Department of Jiangsu Province Rural Science and Technology Division;
Deputy cadres of government bureaus and Provincial cities, such as the Deputy Director of Shenyang Municipal Health Bureau and Deputy Director of Pukou District;
Government bureaus and district cadres of Prefecture-level cities, such as the Director of Yangzhou Municipal Labor Bureau and Binhai County Magistrate;
Regiment-level Army cadres, such as the Political Commissar of the 105th Regiment.

7. Vice-Administrator of Divisioncadres:

Company-owned offices of Ministries and Commissions of the State Council Deputy cadres, such as Deputy Director of the Department of Agriculture and Veterinary Epidemic Prevention;
Provinces, Autonomous Regions, direct-controlled Municipalities, Department Deputy Bureau cadres, such as the Personnel Department Deputy Director of the Jiangsu Province Department of Education;
Deputy Provincial city administration offices and County Bureau cadres, such as Commissioner of Nanjing City Technology Bureau of Scientific and Technological Achievements and Xuanwu Borough Surgeon General;
Prefecture-level city government bureaus and County Deputy cadres, such as Civil Affairs Bureau Deputy Director of Zhenjiang city and Zhangjiagang City Vice-Mayor;
Deputy Regiment-level cadre troops, such as Adviser of the 105th Regiment.

8. Ignoring the Section Chief rank and Vice-Section Chief rank, and below.

Annotation：The treatment of cadres at various levels in every college, scientific research institute, hospital, and other public institutions is equivalent to government cadres at variouslevels, but do not have administrative levels, do not belong to civil service.

If the government cadres at various levels are the standing committee of the party committee at the next higher level, the administrative level is the higher level. For example, the Mayor of Zhangjiagang is at the cadre-level, but if s/he is also on the Municipal Committee of Suzhou, then we identify him/her in the CPC cadre.Once senior cadresreach60 or 65 years of age, they are often transferred to leadership positions in the National People's Congressand the Chinese People's Political Consultative Conference, commonly known as "resigning from a leading post".

Appendix B.Construction of the measures of financial constraints: the WW index and the SA index

According to Whited and Wu (2006), Lin et al. (2011), and Deng and Zeng (2014), the WW index of each company in our sample is estimated by:

WWit=2.817×LongDebtit-0.29×Dividumit-0.636×Logassetit-0.085×IndSalegrowit-4.43×CashRatioit+5.214×IndDebtit+0.947×Control_private +0.373×(Diver Ratio)it

where,

LongDebt: long-term debt scaled by total assets.

Dividend: an indicator variable which is valued at one if the firm has paidacash dividend in a given year, 0 otherwise.

Logasset: the natural logarithm value of book value of total assets.

IndSalegrow:theaveragesalesgrowth ratio of firms within each industry, calculated by the asset-weighted average value of each firm’s sales growth ratio within the same industry. The industries are categorisedaccording to the SIC criterion of China's Securities Regulatory Commission (two digits).

Cash Ratio: cash holding ratio, defined as cash plus short-term investment, scaled by total assets.

IndDebt: the meanlong-termdebtratioweightedbythe value of totalassets of firms within the same industry.

Control_private: an indicator equal to 1 for firms ultimately controlled by private enterprises, 0 otherwise.

Diver Ratio: control-ownership wedge, defined as the difference between control rights and cashflow rights for the ultimate controlling shareholder.

Controlrightsandcashflowrightsoftheultimatecontrollingshareholder are both defined as per La Porta et al. (1999). The WW index is positively related to financial constraintsandthe larger is it, the higher the financial constraint. Following Hadlock and Piece (2010) and Li (2011), the SA index is estimated using the following.

SAit=abs(-0.737×sizeit+0.043×sizeit2-0.040×Ageit)

Wheresize denotes the natural logarithm oftheinflation-adjusted book value of total assets, and Age refers to the number of years from a firm’s incorporation year to the observation year. We use incorporation year rather than IPO year here because financial performance of a firm before listing canaffect its performance after listing. According to Hadlock and Piece (2010), the SA index is a reverse index of financial constraint andthe larger is it, the less financial constraint.

For robustness, in our unreported results, we have replaced the value of Age with the number betweenthecurrent year and the listed year of the company. These results are quantitatively similar to the reported results in this paper.

Table A1: Summary statistics of financial constraints and market frictions on three sub-samples

This tablepresentsand compares the summary statistics of financial constraints (measured by the WW index and the SA index) on three mutually exclusivesubsamples: state-owned firms (Panel A), non-state-owned firms with political connections (Panel B), and non-state-owned firms without political connections (Panel C).Panel D compares differences in financial constraints and the market frictions between the two sub-samples. TheWWindex is estimated using Whited and Wu (2006) and Lin et al. (2011),and the SA index is computed as inHadlock and Pierce (2010). Appendix B details the estimation procedures for constructing the two indices. Turnoveris measured by the annual turnover rate of the traded stocks of a company with adjustments for firm size. PINinis computed as in Easley et al. (2008).

Panel A: State-owned firms

Variable / Obs. / Mean / Std. Dev. / Min / Max
WW / 6084 / -12.7282 / 3.1269 / -42.3723 / 1.1245
SA / 6084 / 2.0428 / 1.4170 / 0.0001 / 11.1267
Turnover / 6084 / 23.4232 / 3.2249 / 15.0825 / 42.0090
PIN / 6074 / 0.12700 / 0.06248 / 0.0058 / 1

Panel B: Non-state-owned firms with political connections

Variable / Obs. / Mean / Std. Dev. / Min / Max
WW / 2699 / -10.2841 / 4.1191 / -40.0068 / 2.0383
SA / 2699 / 1.2920 / 1.0922 / 0.0006 / 6.4009
Turnover / 2699 / 23.6064 / 3.7874 / 15.9329 / 44.4870
PIN / 2692 / 0.1162 / 0.0595 / 0 / 0.4490

Panel C: Non-state-owned firms without political connections

WW / Obs. / Mean / Std. Dev. / Min / Max
SA / 679 / -10.3239 / 4.8542 / -40.5217 / -0.1312
Turnover / 679 / 1.2675 / 1.04714 / 0.0083 / 4.8598
PIN / 679 / 23.2442 / 4.1620 / 15.5339 / 43.8392
WW / 671 / 0.1213 / 0.0652 / 0.0072 / 0.3806

Panel D: Differences in financial constraints and market frictions: Comparing the three sub-samples

Variable / Differences in mean values
(Panel A minus Panel B) / Differences in mean values
(Panel A minus Panel C) / Differences in mean values
(Panel B minus Panel C)
WW / -2.4441***
(-27.5095) / -2.4043***
(-12.6174) / 0.0398
(0.1965)
SA / 0.7507***
(27.0188) / 0.7752***
(17.5787) / 0.0245
(0.5408)
Turnover / -0.1831**
(-2.1851) / 0.1790
(1.0851) / 0.3622**
(2.0627)
PIN / 0.0108***
(7.7292) / 0.0057**
(2.1664) / -0.0051*
(-1.8405)

Table A2. Robustness test 2: An alternative measure of stock market illiquidity in the baseline models

This table presents regression results on the robustness test using an alternative measure of stock market illiquidity, Illiquidity, computed in Amihud (2002).The dependent variables are the WW index calculated as in Whited and Wu (2006) and Lin et al. (2011) and the SA index using Hadlock and Pierce (2010).Statedummyisadummy variable denoting state-owned companies. If the actual controller of the firm is state-owned company, Statedummy=1, else Statedummy=0. The definition of actual controller is similar to that of La Porta et al. (2009). Firm-Size is measured as the log value of the total asset of a firm, Firm-Age is the number of years from a firm’s IPO year to the observation year, ROA is annual return divided by total asset of firm, Tobin’s q equals the market value of equity plus the book value of total debt divided by the book value of the total assets, Education denotes the average education level of firm’s board members and direct senior managers. The education scores consist of four levels: 1-High school and below, 2-bachelor, 3-master, 4-Phd. Members of firm’s board and senior managersare: Chairman of the Board, Vice-Chairman, independentDirectors, non-independent Directors, Secretary of the Board, General Manager, CEO, Deputy General Manager, Vice-President, CFO, other chief officers. Lev denotes firm leverage measured as the log ratio of one year lagged equity to one year lagged assets. All independent variables are lagged one year. The t-statistics are in brackets. ***, **, and * denote significance levels of 1%, 5% and 10%, respectively.

Dep. var.: WW index / Dep. var.: SA index
(1) (2) (3) (4) (5) (6) (7) (8)
State-dummy / -4.3894*** / -4.7021*** / 0.4997*** / 0.2534*
(-6.624) / (-7.387) / (3.230) / (1.650)
Illiquidity / 0.3557*** / 0.3689*** / 0.3766*** / 0.3882*** / -0.0609*** / -0.0347 / -0.0833*** / -0.0429*
(3.787) / (4.109) / (3.700) / (4.056) / (-2.710) / (-1.543) / (-3.632) / (-1.838)
Illiquidity ×Statedummy / -0.4183*** / -0.3873*** / 0.0693*** / 0.0299*
(-5.374) / (-5.141) / (3.835) / (1.715)
PC / -0.0894*** / -0.0976*** / 0.0142*** / 0.0063*
(-6.066) / (-7.142) / (4.029) / (1.797)
Illiquidity ×PC / -0.0084*** / -0.0078*** / 0.0018*** / 0.0007*
(-5.109) / (-4.955) / (4.568) / (1.722)
Firm-Size / -0.1225 / -0.2955*** / -0.1587 / -0.2969*** / 0.0202 / 0.4750*** / 0.0116 / 0.4663***
(-0.761) / (-2.947) / (-0.961) / (-2.931) / (0.524) / (18.943) / (0.301) / (18.997)
Firm-Age / 0.1178** / 0.0516** / 0.1041** / 0.0474** / -0.3264*** / -0.0275*** / -0.3286*** / -0.0278***
(2.542) / (2.180) / (2.228) / (2.025) / (-32.971) / (-8.165) / (-33.489) / (-8.179)
Education / -0.1051 / -0.1501* / -0.1411 / -0.2073** / 0.0262 / 0.0216 / 0.0208 / 0.0202
(-0.959) / (-1.660) / (-1.262) / (-2.258) / (1.005) / (1.164) / (0.801) / (1.090)
ROA / 0.2883 / 0.0181 / 0.3124 / 0.0356 / 0.2501* / 0.1278 / 0.2704** / 0.1428
(0.599) / (0.039) / (0.642) / (0.076) / (1.870) / (0.800) / (2.010) / (0.891)
Tobin’s q / 0.0930 / 0.0534 / 0.1177** / 0.0733 / 0.1650*** / 0.1797*** / 0.1644*** / 0.1806***
(1.613) / (0.983) / (2.073) / (1.349) / (8.928) / (7.686) / (9.055) / (7.745)
Lev / -0.2417* / -0.3192** / -0.2401* / -0.3226** / 0.0370 / 0.0711** / 0.0371 / 0.0700**
(-1.692) / (-2.553) / (-1.656) / (-2.568) / (1.019) / (2.418) / (1.020) / (2.389)
FE/RE / FE / RE / FE / RE / FE / RE / FE / RE
Year Fixed effect / Yes / Yes / Yes / Yes / Yes / Yes / Yes / Yes
Within R2 / 0.0701 / 0.0673 / 0.0704 / 0.0677 / 0.8292 / 0.8084 / 0.8280 / 0.8067
Observations / 7300 / 7300 / 7333 / 7333 / 7300 / 7300 / 7333 / 7333

Table A3. Robustness test: An alternative for stock trading illiquidity using Amihud (2002)in the enhanced models

This table presents regression results on the robustness test using an alternative measure of stock market illiquidity, Illiquidity, computed in Amihud (2002). The dependent variables are the WW index calculated as in Whited and Wu (2006) and Lin et al. (2011) and the SA index using Hadlock and Pierce (2010).PCL, PCM,andPCH are three dummy variables denoting firms in the bottom 40%, the middle 20%, and the top 40% of the sample sorted by the PC index, respectively. Firm-Sizeis measured as the log value of the total asset of a firm, Firm-Age is the number of years from a firm’s IPO year to the observation year, ROA is annual return divided by total asset of firm, Tobin’s q equals the market value of equity plus the book value of total debt divided by the book value of the total assets, Education denotes the average education level of firm’s board members and direct senior managers. The education scores consist of four levels: 1-High school and below, 2-bachelor, 3-master, 4-Phd. Members of firm’s board and senior managersare: Chairman of the Board, Vice-Chairman, independentDirectors, non-independent Directors, Secretary of the Board, General Manager, CEO, Deputy General Manager, Vice-President, CFO, other chief officers. Lev denotes firm leverage measured as the log ratio of one year lagged equity to one year lagged assets. All independent variables are lagged one year. The t-statistics are in brackets. ***, **, and * denote significance levels of 1%, 5% and 10%, respectively.

Dependent variable ： / WW index SA index
(1) (2 ) (3) (4 ) (1) (2) (3) (4)
PC / -0.0500***
(-27.07) / -0.0246***
(-6.01) / -0.0180***
(-3.93) / -0.0308***
(-7.79) / 0.0043***
(10.90) / 0.0033***
(4.60) / -0.0009
(-1.04) / 0.0017**
(2.53)
Illiquidity / 0.4650***
(10.77) / -0.4615***
(-50.24)
PCM / -3.8426***
(-5.30) / -3.7012***
(-5.24) / 0.3218**
(2.44) / 0.0904
(0.68)
PCH / -2.5118***
(-4.75) / -2.3057***
(-4.54) / 0.4473***
(4.64) / 0.0675
(0.71)
Illiquidity×PCL / 0.1374**
(2.46) / 0.2669***
(3.87) / 0.2857***
(4.36) / -0.1661***
(-16.20) / -0.0500***
(-3.99) / -0.0294**
(-2.43)
Illiquidity ×PCM / 0.1520***
(2.72) / -0.1364
(-1.50) / -0.1029
(-1.17) / -0.1568***
(-15.17) / -0.0084
(-0.51) / -0.0110
(-0.67)
Illiquidity×PCH / 0.1031*
(1.85) / -0.0403
(-0.56) / 0.0065
(0.09) / -0.1565***
(-15.26) / 0.0075
(0.58) / -0.0131
(-1.05)
Firm-Size / -0.1556
(-1.54) / -0.2894***
(-3.92) / 0.0115
(0.63) / 0.4625***
(37.94)
Firm-Age / 0.1052***
(3.54) / 0.0491**
(2.40) / -0.3284***
(-60.75) / -0.0277***
(-9.83)
Education / -0.1329*
(-1.72) / -0.2008***
(-2.97) / -0.1385 *
(-1.79) / 0.0202*
(1.73)
ROA / 0.4964
(1.16) / 0.0714
(0.17) / 0.0206
(1.46) / 0.1398*
(1.75)
Tobin’s q / 0.3586
(0.80) / 0.0764**
(2.06) / 0.2617***
(3.21) / 0.1804***
(27.19)
Lev / 0.1205***
(2.92) / -0.3155***
(-3.05) / 0.0380*
(1.83) / 0.0699***
(3.79)
OLS/ FE/RE / OLS / FE / FE / RE / OLS / RE / FE / RE
Year Fixed effect / Yes / Yes / Yes / Yes / Yes / Yes / Yes / Yes
Adjusted R2/
Within R2 / 0.1524 / 0.1093 / 0.0719 / 0.0692 / 0.7017 / 0.8060 / 0.8272 / 0.8065
Observations / 7982 / 7982 / 7333 / 7333 / 7982 / 7982 / 7333 / 7333
Illiquidity×PCL-
Illiquidity ×PCH
(F statistics) / 0.0343**
(3.87) / 0.3072***
(14.99) / 0.2922***
(18.97) / -0.0096***
(7.93) / -0.0575***
(15.89) / -0.0163***
(5.89)
p-value / 0.04921 / 0.000 / 0.000 / 0.0049 / 0.000 / 0.0152

Table A4.Robustness test: Sub-periods around the Chinese split-share reform in 2005

This table presents the weakening effect of PC on Turnover and PIN’s financialconstraints effect. The dependent variable is WW index calculated as per Whited and Wu (2006) and Lin et al. (2011). The independent variables are calculated as follows. PC index is computed as per the method developed by Fan et al. (2007) and Luo and Ying (2014), which is presented in detail in Appendix A. Turnover is measured by the annual turnover rate of firm’s stock and adjusted by size effect. PIN index is computed as per Easley et al. (2008).Firm-Size is measured as the log value of the total asset of a firm, Firm-Age is the number of years from a firm’s IPO year to present, ROA is annual return divided by total asset of firm, Tobin’s q equals the market value of equity plus the book value of total debt divided by the book value of the total assets, Education denotes the average education level of firm’s board members and direct senior managers. The education scores consist of four levels: 1-High school and below, 2-bachelor, 3-master, 4-Phd. Members of firm’s board and senior managersare: Chairman of the Board, Vice-Chairman, independentDirectors, non-independent Directors, Secretary of the Board, General Manager, CEO, Deputy General Manager, Vice-President, CFO, other chief officers. Lev denotes firm leverage measured as the log ratio of one year lagged equity to one year lagged assets. All independent variables are lagged one year. The t-statistics are in brackets. ***, **, and * denote significance levels of 1%, 5% and 10%, respectively.

Dependent variable： / WW index SA index
(1) (2) (3) (4) (5) (6) (7) (8)
<2005 >=2005 <2005 >=2005 <2005 >=2005 <2005 >=2005
PC / -0.0605 / -0.0216 / -0.0398** / -0.0009 / 0.0009 / 0.0033 / 0.0000 / -0.0052***
(-0.544) / (-1.588) / (-2.229) / (-0.140) / (0.109) / (1.281) / (0.012) / (-3.858)
Turnover / -0.1229 / -0.0356 / -0.0132 / 0.0290***
(-0.490) / (-1.340) / (-0.838) / (6.469)
Turnover×PC / 0.0017 / 0.0003 / -0.0000 / -0.0002*
(0.333) / (0.601) / (-0.110) / (-1.657)
PIN / -4.2435 / 5.6452*** / 0.2193 / -1.8905***
(-0.914) / (4.314) / (0.870) / (-4.984)
PIN×PC / 0.0966 / -0.1274*** / -0.0000 / 0.0430***
(0.966) / (-4.883) / (-0.003) / (5.612)
Firm-Size / 0.0706 / -0.1266 / 0.0077 / -0.1054 / 0.2646*** / -0.1130*** / 0.2404*** / -0.1192***
(0.132) / (-0.652) / (0.015) / (-0.540) / (4.859) / (-2.588) / (4.505) / (-2.746)
Firm-Age / 1.0277*** / -0.2911*** / 1.0384*** / -0.2779*** / -0.5266*** / -0.2566*** / -0.5234*** / -0.2579***
(7.886) / (-4.842) / (7.872) / (-4.444) / (-43.292) / (-21.072) / (-43.063) / (-19.846)
Education / -0.1699 / -0.1985 / -0.1598 / -0.1888 / 0.0146 / 0.0200 / 0.0121 / 0.0137
(-0.869) / (-1.309) / (-0.795) / (-1.258) / (1.027) / (0.623) / (0.861) / (0.420)
ROA / 0.7770 / 0.3552 / 0.7427 / 0.3256 / 0.1839 / 0.2617* / 0.1750 / 0.2624*
(0.435) / (0.831) / (0.411) / (0.772) / (1.288) / (1.873) / (1.211) / (1.938)
Tobin’s q / -0.6552* / 0.0832 / -0.6782* / 0.1051* / -0.0470 / 0.1728*** / -0.0569 / 0.1596***
(-1.731) / (1.299) / (-1.738) / (1.720) / (-1.184) / (7.399) / (-1.386) / (7.416)
Lev / -0.3710 / -0.1471 / -0.3701 / -0.1247 / 0.0780** / 0.0120 / 0.0735* / 0.0005
(-0.946) / (-0.873) / (-0.934) / (-0.739) / (1.980) / (0.293) / (1.828) / (0.011)
Fixed Effect / FE / FE / FE / RE / FE / FE / FE / FE
Year Fixed effect / Yes / Yes / Yes / Yes / Yes / Yes / Yes / Yes
Within R2 / 0.2165 / 0.0437 / 0.2187 / 0.0471 / 0.9205 / 0.6958 / 0.9201 / 0.6954
Observations / 1641 / 5722 / 1635 / 5717 / 1641 / 5722 / 1635 / 5717