Three Essays on Political Uncertainty in China

Abstract

The view that uncertainties emanating from the political system increase the information asymmetry between firm insiders and outside investors has reached an agreement (Bird et al., [2017]; Chen et al., [2018]; Dai and Ngo [2018]). In this three-chapter dissertation, which contains three papers, I contribute to this relatively new area of research by examining how information asymmetry induced by political uncertainty impacts the stock market, i.e. probability of information based trading; managerial decision making, i.e. earnings management; and whether government subsidies pervasive in the specific setting of China provide an additional channel to affect this managerial decision making.Chapter 1, titled POLITICAL UNCERTAINTY AND THE PROBABILITY OF INFORMATION BASED TRADING (PIN), examines the effect of political uncertainty on information asymmetry, measured by the Probability of Information Based Trading (PIN) - which is positively associated with information asymmetry - between firms’ insiders and outside investors using local government turnover in China as a source of plausibly exogenous variation in uncertainty. The effect is analyzed through a two-way fixed effect model on publicly listed Chinese firms from 2001 to 2010. The results indicate that PIN decreases during the year of city Party Secretary turnover, suggesting a positive effect of political uncertainty on reducing information asymmetry between firms’ insiders and outside investors. The results of event study suggest that the effect is very short run, dissipating after a year. Chapter 2, titled POLITICAL UNCERTAINY AND EARNINGS MANAGEMENT, examines the effect of political uncertainty on firms’ accruals-based earnings management and real earnings management using local government turnover in China as a source of plausibly exogenous variation in uncertainty. Two-way fixed effect models are combined with hand-collected data on changes of government officials over the period 2007 to 2017 to study this question. The results suggest that firms on average move 0.5% more of total assets into discretionary accruals during the year of local government turnover. Nevertheless, real earnings management is not affected by local government turnover. An event-study analysis shows that the effect on accruals management dissipates after one year. Chapter 3, titled POLITICAL UNCERTAINY AND GOVERNMENT SUBSIDIES, examines whether the amount of government subsidies received by firms change during the year of political uncertainty, measured by the turnover of top official at city level. The question is tested using a two-way fixed effect model controlling city fixed effect, industry fixed effect, and year fixed effect. Historical changes of top official for each city are hand-collected, and then financial data of all firms publicly listed in Shenzhen and Shanghai Stock Exchanges in China from 2007 to 2018 are merged to construct the final sample. The results suggest that firms receive qualitatively unchanged subsidies from government during the year of city Party Secretary. An event-study analysis indicates that city Party Secretary turnover does not affect government subsidies allocation in the long run.