UC Berkeley

This paper uses the sudden deaths of retired government officials who were acting as independent directors of private firms to study the effects of losing political connections on the firm’s economic performance. Employing an event study, we find that, if a private firm loses political connections because of the sudden death of an independent director who was previously a government official, its stock price drops 1.47% on average within ten trading days. Moreover, after the sudden loss of political connections, there is a reduction in the economic benefits (e.g., bank loans, tax preference, and government subsidies) that a private firm can get from the government or banks, which provides a reasonable explanation for the negative stock price reaction. This paper also finds that, when a politically connected private firm unexpectedly loses its political connection, it increases investments in physical capital in order to regain its competitive advantage, which suggests that physical capital serves as a substitute for political capital.