Political control and internal governance in state-owned enterprises: Evidence from party-building reform in China

Abstract

Previous research finds that state-owned enterprises (SOEs) that are subject to agency problems associated with political control operate less efficiently than other companies. Other research suggests that internal governance can mitigate agency problems. We combine these lines of research and examine whether the degree of cost stickiness in Chinese SOEs increases or decreases with implementation of party-building reform. Party-building reform elevates the status of the Party Decision Committee (PDC), an internal group of managers and staff representatives empowered to represent party interests. A more influential PDC may enhance political control while, at the same time, a stronger PDC may serve an internal governance role that mitigates agency-related problems. Our results provide evidence that cost stickiness is significantly lower in SOEs after implementation of party-building reform, supporting an internal governance effect as opposed to a political control effect of the PDC on management decision-making. Our evidence indicates that the reduction in cost stickiness occurs when the PDC is more independent from managers and more actively engaged in governance. Further analysis shows that the effect of PDC internal governance is more pronounced in firms where agency problems are apparently greater, traditional governance mechanisms are weaker and political influence is lower, supporting our main results.