POLITICAL CONNECTION, REPORTING TRANSPARENCY, AND RISK DISCLOSURE

Abstract

89 pagesI examine the effect of losing political connections on corporate reportingtransparency and risk disclosure. Political cost literature suggests that firms receiving political attention are more likely to use accounting choices to reduce reported profits, likely resulting in less transparent disclosure. One of China’s anti-corruption policies, Rule 18, took effect in October 2013 and mandated independent board directors above certain civil ranks to resign from firms, constituting increasing political costs to firms. My empirical analysis employs this policy shock and a difference-in-difference research design. Using composite textual measures of reporting transparency and risk disclosure, I find that losing political connection does not affect reporting transparency or risk disclosure significantly, providing no support to the hypothesis. More nuanced analysis reveals that firms with high R&D intensity reduce their reporting transparency after Rule 18 more saliently, aligning with the increasing proprietary cost concerns leading to a less transparent information environment after firms lose their political connection. Finally, I provide the explanations for the insignificant effect of Rule 18 on reporting transparency and risk disclosure: firms don’t consider the textual transparency a counterpart of financial reporting quality in Hope et al. (2020) and this is partly due to investors’ disinterest. Risk disclosure also lacks the information content and the regulation does not significantly affect several underlying risks. Overall, my findings provide mixed evidence related to the effect of political connections on Chinese firms’ information environment and illustrate the difference in investors’ reaction to the linguistic disclosure information between China and the US