The impact of political ties on R&D investment and firm
performance: results from Chinese firms
Master Thesis International Business and Management Ai Xie S2530651
a.xie@student.rug.nl Supervisors： Dr. M.J. (Mariko) Klasing
Co-assessor:
Mr. P.J. (Paulo) Marques Morgado
Faculty of Economics and Business University of Groningen
Abstract
The purpose of this paper is to investigate the impact of political ties on R&D investment and firm performance. This paper posits that there is a non-monotonic relationship between political ties and R&D investment, and R&D investment could serve as a bridge connects political ties and firm performance. The study employs secondary data from 192 Chinese firms across multiple sectors to test hypotheses. Empirical results provide partial supports for hypotheses by showing that: (1) there is a nonlinear (U-shaped) relationship between political ties and R&D investment, while (2) the impact of political ties on firm performance is insignificant, and the R&D investment did not have a mediating effect on relationship between political ties and firm performance.
Key words: political ties, R&D investment, firm performance, China
Acknowledgements
In this chapter, I would like to take the time to express my gratitude to everyone who help me complete this master thesis.
1. Introduction ... 1
2. Theoretical Background and Research Hypotheses... 3
2.1 Political ties ... 3
2.2 Political ties in Chinese culture ... 6
2.3 Political ties and R&D investment ... 10
2.4 Political ties and firm performance ... 13
2.5 Conceptual framework ... 15 3. Methodology ... 16 3.1 Measurements ... 16 3.1.1 Political ties ... 16 3.1.2 R&D investment ... 17 3.1.3 Firm performance ... 17 3.1.4 Control variables ... 18 3.2 Data Collection ... 18 3.3 Econometric modeling ... 19 4. Results ... 19 4.1 Descriptive statistics ... 19 4.2 Tests of hypotheses ... 20
5. Discussion and Conclusion ... 24
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1. Introduction
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China (Peng, & Luo, 2000). In such an environment, close political ties with governments could be a wise strategy that help entrepreneurs overcome institutional imperfections and avoid ideological discriminations.
Despite increasing researches on this topic, several aspects of social ties’ studies still remain ambiguous. First, few extant studies considered political ties explicitly or distinguished effects of business and political ties, which tended to confuse the impact of political ties with the impact of business ties. Because these two types of ties involve different resources, their value may differ from environmental variances. Second, even though previous researches already found empirical supports for the social ties that have effects on firms’ financial performance, the relationship between political ties and R&D investment as well as their impacts on firm’s performance are not yet covered. Meanwhile, the relationship between political ties and firm performance is not always easy to observe (Sheng, et.al, 2011). Third, the core argument of political ties is the supportive function of political ties by providing various information and opportunities (Li, et.al, 2008). Based on resources-based view, such indirect supports benefited from political ties are able to help firms create or sustain competitive advantages and then ensure long-term performance (Hillman, 2005). However, extant studies based on political embeddedness perspective have disclosed the dark side of political ties, which indicated that political ties not only provide opportunities but also act to constrain firms’ developments, for instance, the deep political embeddedness will hamper firm’s performance (Sun, et.al, 2010). Therefore, the impact of political ties on firms’ organizational strategies and performance is still unclear.
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micro-macro link of business management. In particular, this paper analyzes the role of affiliation with Chinese Communist Party (CCP) in influencing on firms’ innovation strategies and performance. Distinct features of Chinese market that set it apart from other emerging economies are the continuing controlling role of CCP and the continuing ideological discrimination of non-state owned enterprises. This paper implements the People’s Congress membership (PCM) as the measure of political status that represents a close affiliation with the only ruling party in China. Due to People’s Congress members interact with government officials and bank managers directly, managers would create an avenue for higher achievements through setting up connections with core political and economic figures. Thus, the empirical task of this study is to examine whether PCM has impacts on firms’ innovation strategy and the profitability of firms.
To carry out its purpose, this research relies on a formulation and testing of specific hypotheses based on data collected from 192 Chinese firms. This paper is organized as follows. First, a literature review and theoretical framework are given regarding the political ties, R&D investment, firm’s performance and Chinese economy. Then, according the theoretical framework, hypotheses are generated. Following the literature review and the theoretical framework, the research design, methodology and data analysis will be elaborated. Then, I will report my empirical results of the sample firms. Finally, I will provide a discussion, a conclusion and future research directions.
2. Theoretical Background and Research Hypotheses
2.1 Political ties
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more important for managers for facilitating market exchanges and would have a more powerful effect upon firms’ performance (Sun, et.al, 2010).
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agency theory, upper echelons theory suggests that heterogeneity in companies’ activities or outcomes is largely depending on differences among firms’ leaders. Moreover, executives perceive their situations and make choices through high-personalized lenses that are constituted by executives’ experiences, personalities, beliefs and values, so that firms’ owners should focus on how to select and develop upper level executives. Therefore, studying on one aspect of top executives’ background (political ties) may explore the link between micro-level managers’ input and macro-level firms’ performance.
2.2 Political ties in Chinese culture
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amount of time and energy to set up interpersonal networks, Chinese managers enjoy much passion on cultivating interpersonal relationships to facilitate their businesses. Moreover, the Chinese government still controls a huge amount of scarce resources, such as bank loans, tax, and land, so that the cooperation with Chinese government offers shortcuts to obtain those invaluable resources (Sheng, et.al. 2011). Thus, China is an ideal research context to explore the impact of political ties on business strategies and firms’ performance.
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are two concepts in Chinese philosophy that could interpret the importance of a
Guanxi network for Chinese. Firstly, face (Mianzi or Lian in Chinese) represents the
basic social philosophy and roots in Chinese interpersonal relationships. In Chinese culture, an individual’s face is an intangible asset that determined by one’s credibility, reputation, power, social position and material wealth. Individual could obtain higher position and manipulate the dynamics of a Guanxi network if he or she has superior face. Therefore, it is Chinese tradition to achieve personal prestige without losing any face as well as respecting others’ face within a Guanxi network. Secondly, Renqing, the other Chinese traditional concept, relates with social exchanges. It acts as a precondition and social currencies to motivate one to develop one’s Guanxi network through which people taking advantages of each other (Yang, 1994). Generally, the reciprocity, the most essential implicit idea of Guanxi network, originates from
Renqing philosophy. The above two fundamental philosophies generated several
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middle. Therefore, Guanxi is invaluable and intangible resources for individual and firms to induce cooperation and create successful transactions. Meanwhile, Guanxi is an efficient tool to bridge the gaps between stakeholders like governments. Firms develop Guanxi networks could overcome institutional pitfalls and mobilize complementary benefits by arbitraging different networks in Chinese instable and uncertain market. As one essential representation of Guanxi network, political ties concentrate on building connection with governments. Practically, within such a special Chinese political system, Guanxi networks with governments often consider as a key component that determine the long-term survival of firms, for instance, governments control the legitimacy of firms (Wank, 1996). From the institutional literature, the institutional environment, including norms, rules, regulation and culture, has significant influence on firms’ organization and behavior (Hitt, & Hillman, 1999). According to institutional theory (Zaheer, 1995), it is necessary for executives to understand and appropriate utilize Guanxi networks to gain the tacit knowledge to overcome competitors. Additionally, public authorities set up rules and regulations, and provide enforcement mechanisms to control the market, such as regulation on prices, licenses, labor issue, etc. As continues economic transitions, the utilization of political ties becomes increasingly pervasive and intensive at the firm level. For example, the close relationship with governments can be a persuasive reason why state-owned enterprises have the extraordinary performance recently in global markets.
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between government officials and managers. Moreover, political ties may have liabilities because government officials have to rotate their positions across different departments and geographic locations, especially for high-level officials. Even though enterprises may incline toward establishing close political ties, government officials are less motivate to evolve in this long-term relationship. Therefore, political ties become an interesting research problem in China.
In this study, I focus on firm-level political ties that reflect networks between firms and governments (formal institutions). Based on above arguments, I expect to explore to what extent micro interpersonal ties could affect macro firm-level organizational strategies and performance.
2.3 Political ties and R&D investment
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resources. One reasonable answer for this problem is that state-owned enterprises enjoyed close and intensive relationships with governments that could help firms create first-move advantages. In order to compete with state-owned enterprises, private firms are enthusiastic to forming their own political ties. Moreover, in 1990s after ten year economic transition, many Chinese government officials quit their job and ventured into business (called Xiahai in Chinese), because abundant business opportunities were appeared in Chinese market at that period. Those former government officials brought plenty of political ties into business networks. Therefore, it seems gaining success in Chinese market depends on whether managers could aware or follow the government intentions.
Moreover, Chinese government has already put the development of science and technology at the center of China's modernization project, thus, innovation has regarded as the key engine for catching up with advanced industrialized countries (Liu et al., 2011). China’s governments view innovation as important both to the domestic economy’s development and to the global competitiveness of Chinese enterprises (Gordon Orr & Erik Roth, 2012). As active participating in innovative activities, some of China’s achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind- and solar-power industries. Other developments, such as local companies in domestically oriented consumer electronics, instant messaging, and online gaming, may well be escaping the notice of executives who are not on the ground in China. Meanwhile, Chinese firms also benefit from their government’s emphasis on indigenous innovation, underlined in the latest Chinese five-year plan. China has already established the seeds of 22 Silicon Valley–like innovation hubs in different geographic locations.
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Barge-Gil, 2010). Unfortunately, previous literatures have made limited empirical researches on the relationship between political ties and firm R&D investment, despite some scholar indicated political ties have impacts on firm performance (Li, et.al, 2008). This study desires to explore the impact of political ties on firms’ innovation strategies.
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Political ties affect R&D investments through not only influencing the environmental fit but also determining organizational competences on economic activities. However, due to the political interference and managerial disincentives, political ties could have negative effects on firms’ organizational competences. Moreover, the goal of governments is seeking political supports and legitimacies among publics (generally through election and votes), and local governments should take responsibilities to increase the personal income and improve public living standards in order to get publics’ supports. However, governments pursuing objectives that are beneficial to publics might lead to political interferences on the firms’ operations and activities that firms might benefit from (Dinc, 2005). Further, political interferences damage managers’ incentives to refine organizational routines effectively, which lead to the rigidity of internal organizational pattern. Wu (2011) indicated that the high dependence on favorable treatments from the government to gain the success of business would reduce managers’ incentives to improve innovation efficiency. Governments’ interferences provide a chance for managers to impute the innovation inefficiency to governments. Meanwhile, extant researches suggest that firms rely on embedded ties may indirectly undermine exploration of new and valuable information or resources, since managers already accustomed themselves to using existing ties for business advancements (Uzzi, 1991). Even worse, in order to obtain abundant resources from governments, the manager would like to offer a bribe to government officials. As a result, such unethical practices incur inappropriate allocation of firms’ resources, damages of firms’ reputations and violations of shareholders’ interests. Therefore, this paper generates a hypothesis as follows:
H1: there is a non-monotonic relationship between firms’ political ties and R&D investment.
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Innovation is widely considered as a key stimulus to national economy’s growth (Guan, & Yan, 2014). In the past three decades, China has increasingly invested in R&D activities substantially. The expenditure achieved a new record of 162 billion US dollar in 2012, which comprised 2 percent of China’s GDP. Meanwhile, China became the second most R&D-intensive country in 2009 (OECD, 2012). Moreover, various innovation-supportive policies launched by Chinese government recently, including developing national capacities of innovation and creating the appropriate innovative environment. Huge efforts on R&D or innovation developments are persuasive evidences that China expanding great energy in transferring labor-intensive exporting-led economy into a more sustainable innovation-driven national economy which also announced in China’s 12th five-years plan.
Moreover, as Chinese economy surged in last thirty years, Chinese average personal income grows rapidly from 445 CNY/Year in 1952 to 56339 CNY/Year in 2014
(National Bureau of Statistics of China), thus Chinese market losing the attraction of foreign investments as the world cheapest assembly manufactory gradually. In order to keep the prosperity of Chinese economy, Chinese governments have to transform the economic structure from manufacture-based into technology-base or innovation-based. As the result, it incentives firms to increase investments on R&D, and then align the tendency of national economy’s development. For instance, due to innovative products and unique organizational structures, several Chinese firms are heated debated by global entrepreneurs like Alibaba, Huawei and Xiaomi. In 2013, Huawei invested $5 billion in R&D versus $4.9 billion by Ericson that is a strong
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According to resource-based view, those intangible and firm-specific resources could increase operational efficiency and effectiveness of firms, thus, creating firm specific advantages is engine for extraordinary performance (Barney, 1991). Political capital is driven from firms’ political ties which can be consider as specific resources for creating firm specific advantages. In general, firms develop new products or services in order to obtain better business returns. In a new product launched process, governments have impacts on market demand and product’s legalization, thus managerial political ties can benefit or hinder an enterprise’s innovation and economic prosperity (Guan, & Yam, 2015). However, previous studies had mixed findings on the value of political ties for firm performance. Some studies found positive impacts (Wu, et.al, 2013), while others noted did not find any direct effect and even found negative impacts (Wang, et.al, 2009; Faccio, 2006). As aforementioned, the impact of political ties on firms’ performance is unclear; this study try to explore whether there is an indirect link between political ties and firms’ performance where firms’ R&D strategies play a mediate role between political ties and firms’ performance. Therefore, following hypotheses generated:
H2: Firms’ R&D investments is positive related with firms’ performance.
H3: There is a non-monotonic relationship between political ties and firm’ performance.
2.5 Conceptual framework
16 Figure 1 Conceptual framework
3. Methodology
3.1 Measurements
3.1.1 Political ties
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is not a membership in either the People’s Congress or the People’s Political Consultative at any level, the value of the variable set to zero. In contrast, Bai (2006) applied the total government ownership percentage to measure political ties that ignored the managers’ interpersonal relationship. In general, state-owned firms show higher level of government ownerships than other types of firms, but previous research shows that non-stated owned firms are more likely to engage in the social network to avoid uncertainties (Park, & Luo, 2001).
3.1.2 R&D investment
This study operationalizes the R&D investment using the R&D investment intensity, which means the percentage of a firm’s annual R&D expenditure to its annual revenue (Zhang, et.al, 2014).
3.1.3 Firm performance
18 3.1.4 Control variables
This research will include control variables which relate to R&D investment and firm performance. First, firm size is highly related to firms’ resources and sales (Li, et.al, 2008), this research measures firm size as logarithm of the number of employee. Generally, large firms may have more resources to devote to innovative activities and more ambitions to expand their market share. Second control variable is ownership structure. Park and Luo (2011) indicated that non-stated owned firms are more likely to invest for the political connections. Moreover, due to the nature advantage of state-owned corporations, they are able to obtain more resources and secure legitimacy from the government. As this study focuses on Chinese firms, the firm ownership is classified into three group: state-owned enterprises, collectively owned enterprises, and privately owned enterprises. This paper will examine ownership as dummy variable (collectively owned enterprises=1, state-owned enterprises =0, privately owned enterprises=the omitted group).
3.2 Data Collection
19 3.3 Econometric modeling
Based on hypotheses noted above, the regression model is appropriate for this empirical analysis. Three equations for regression models as follows:
R&D investment = β1PT+ β2PT2 + α1 X + e, (1) Performance = β3 R&D investment + α2X + e, (2) Performance = β4PT + β5PT2 + α3X + e, (3)
Performance = β6PT + β7PT2 + α4X + β8 R&D investment + e, (4)
Where PT is political ties, and X presents a set of control variables.
4. Results
4.1 Descriptive statistics
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decentralization strategy and implemented market-oriented economy. However, in fact, 3.4% of Chinese firms were state-owned enterprises, 3.3% of firms were collectively owned enterprises, and 79.1% privately owned enterprises in year 2012 (www.pedata.cn). Therefore, due to the high uncertainty and risk of R&D activities, firms need adequate information and resources to support their innovation strategies. Compare with privately owned enterprises, state-owned and collectively owned enterprises enjoyed significant advantages about obtaining enough resources (Chen, et.al, 2014).
4.2 Tests of hypotheses
According to the econometric modeling, this paper conducts the generalized least square (GLS) regression to test correlation relationships among variables. Table 2 provide estimating results of three models.
As table 2 shows, model 1 is consistent with Hypothesis 1 that predicts a non-monotonic relationship between political ties and R&D investment. From the result of model 1, it indicates political ties have a negative effect on R&D investment, and the effect is significant (β1= -1.657, significant at the 0.05 level). As strengthening Table 1: Descriptive statistics and correlation matrix
Mean S.D. 1 2 3 4 5 6
1. Political ties 3.343 1.127 1.000
2. R&D intensity (%) 4.341 5.588 -0.2276 1.000
3. Return on assets (%) 12.477 30.599 0.0961 -0.0010 1.000 4. Firm size (log No.
employees) 7.412 1.649 0.4774 -0.3323 -0.0641 1.000
5. Ownership1 0.308 0.462 0.0526 0.0690 0.0210 -0.442 1.000
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political ties, firms R&D investment decreasing firstly and then increasing gradually (β2 = 0.184, significant at the 0.1 level). Further, firms’ ownership has significant influence on R&D investment, which means R&D investments of collectively owned enterprises are more strongly dependent on political ties-building efforts. In sum, the empirical result illustrates the non-monotonic relationship between political ties and R&D investments should be the U-shaped relationship, and supports hypothesis 1.
The result for model 2 shows that the R&D investment does not has a significant effect on firm performance (β3 = -0.144). Thus, the impact of R&D investments on firm performance is still not clear, so that hypothesis 2 is not supported.
As we can see from Table 2, results of model 3 and model 4 do not depict political ties have positive or negative effects on firm performance (β4= 5.115, β5=-0.066, β6=4.998, β7=-0.527). Hypothesis 3 predicts that political ties have a non-monotonic relationship with firm performance. In model 3 and 4, the coefficient of political ties is positive, while that of (political ties) 2 is negative, showing that a curvilinear relationship between political ties and firm performance, however, I do not find any significant effect of political ties on firm performance, thus hypothesis 3 is not supported.
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Table 2: The effects of political ties on R&D investment and firm performance
R&D intensity ROA ROA ROA
Independent variables Model 1 Model 2 Model 3 Model 4
Direct effect variables
Political ties -1.657** (0.782) 5.115 (4.513) 4.998 (4.526) (Political ties)2 0.184* (0.118) -0.066 (0.682) -0.527 (0.682) R&D intensity -0.144 (0.188) -0.701 (0.187) Control variables Firm size -1.028*** (0.126) -1.426** (0.721) -2.400** (0.726) -2.472*** (0752) Dummy variables Ownership1 0.803** (0.398) 1.532 (2.317) -0.789 (2.210) 0845 (2.305) Ownership2 0.366 (0.521) 0.779 (2.932) -2.521 (3.001) -2.496 (3.011) Constant 14.879*** (1.428) 23.027*** (5.429) 14.296*** (8.246) 15.343 (8.706) R-sq 0.12 0.005 0.026 0.026 F 26.56 1.23 5.13 4.29 No. Of observations 960 960 960 960
Firm size= log Number of employee Firm Performance=ROA
Ownership:1=collectively owned enterprises,2=state-owned enterprises, private-owned enterprise is the omitted group
*p<0.1
**p<0.05
***p<0.01
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and cannot detect the mediating role of R&D investment on the relationship between political ties and firm performance. With respect to time dummies, even though they do not change empirical outcomes, the result of time dummies demonstrates the relationship between political ties and firm performance varies over time. In general, firms showed a decreasing tendency on firm performance from 2009 to 2013, especially year 2012 and year 2013 implied significant negative effects on firm performance.
Table 3: The robustness check with time dummies
R&D intensity ROA ROA ROA
Independent variables Model 1 Model 2 Model 3 Model 4
Political ties -‐1.654** (0.781) 5.074(4.435) 5.084(4.448) (Political ties)2 0.185*(0.118) -0.086(0.671) -0.087(0.672) R&D intensity -0.065(0.185) 0.006(0.184) Control variables Firm size -‐1.052*** (0.126) -1.006 (0.712) -2.035** (0.717) -2.029**(0.744) Dummy variables Ownership1 0.812**(0.397) 1.303(2.277) 0.637(2.261) 0.633(2.266) Ownership2 0.401(0.520) 0.070(2.885) -‐3.073(2.959) -‐3.075(2.691) Year-2010 -‐0.331(0.534) -‐0.409(3.069) -‐0.252(3.308) -‐0.251(3.040) Year-2011 -‐0.191(0.535) -‐2.784(3.075) -‐2.512*(3.044) -‐2.511(3.046) Year-2012 0.338(0.536) -‐14.596***(3.075) -‐14.284***(3.044) -‐14.286***(3.046) Year-2013 0.956*(0.537) -‐11.403***(3.083) -‐11.058***(3.045) -‐11.064***(3.055) Constant 14.865***(1.455) 25.641***(5.523) 17.767***(80267) 17.683***(8.714) R-sq 0.13 0.04 0.06 0.06 F 15.62 5.38 7.13 6.41 No. Of observations 960 960 960 960
Note: Dummy variables: Ownership:1=collectively owned enterprises,2=state-owned enterprises, private-owned
enterprises is the omitted group; time dummies: year-2009 is the omitted group Firm size= log Number of employee
24 5. Discussion and Conclusion
This study revisits an important topic about non-market strategies, and enriches the literature about strategic management by examining impacts of political ties on firms’ R&D strategies and firm performance.
5.1 Theoretical contribution
This paper contributes to existing literatures in following ways. First, this paper has attempted to establish a more informed answer to the question whether political ties have impacts on firms’ organizational strategies and performance. This paper contributes to a better understanding of the role of political ties in R&D investment in transitional economies. Different from previous studies that show a simple positive relationship between political ties and R&D investments, this study illuminates a nonlinear relationship between political ties and R&D investments in the context of Chinese market. According previous literatures, political ties serve as a vital role in R&D investments through facilitating obtainment of government-controlled resources, while the benefit of political ties would plateau after a threshold. However, my empirical results show a non-monotonic relationship (U-shaped relationship) between political ties and R&D investments, indicating mixed effects of political ties. Thus, this study highlights the importance of taking a more detailed approach when studying impacts of political ties on organizational strategies.
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political ties into effective strategy for improving firm performance is still remain unclear. Taken together, the paper provides new insight into political ties research by exploring the mediating effect of R&D investment on relationship between political ties and firm performance. Although political ties have significant impacts on firms’ R&D investments, the result fails to interpret the mediating function of R&D investments. As denying the mediating role of R&D investments, this paper open a new insight for future studies to seeking the other mediating mechanisms that influence the relationship between political ties and firm performance. In sum, this paper confirmed that the relationship between political ties and firm performance is not always easy to observe.
Finally, this paper concludes that firm size have significant effects on both R&D investment and firm performance, even though large firms should enjoy more resources to devote to innovation activities generally. The impact of firm size is consist with Peng and Luo (2000)’s finding, which demonstrated smaller firms typically have to establish managerial ties rapidly to gain legitimacy, so that they can overcoming their liability of age. Meanwhile, large firms with stable business partners and government ties tend to be less enthusiasm about cultivating extra political connections. In contrast with smaller firms, the influence of political ties on large firms’ overall performance may be less displayed (Dubini, & Aldrich, 1991). Thus, this paper stresses that firm size is an important factor influencing firms’ management and performance.
5.2 Managerial implications
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important for Chinese firms, political ties still show a complex effect on firm R&D investment, and its impacts on firm performance still remain unclear. Thus, in such a transitional market, firms should avoid blindness in investments on political connections with governments, and should diminish the dependence on informal supports from external institutions. Third, according to results of political ties on R&D investment, despite Chinese central government launched decentralized managerial policy and considering innovation as a key national economic strategy, empirical results illustrate that China is still in the early stage of innovation-oriented markets. Thus, running a business in this high-risk environment, managers should utilize political ties to achieve useful market information rather than take it as an entrepreneurial opportunity.
5.3 Limitations
27 5.4 Conclusion
This study has provide both the theoretical reason and the empirical evidences in exploring impacts of political ties on firm R&D investments and firm performance in Chinese context. Both theories and results clearly point out the importance of political ties to organizational strategies. According to results, political ties have significant influence on firms’ R&D investment, whereas this paper does not observe an obvious effect of political ties on firm performance and fails to detect the mediating role of R&D investment. Meanwhile, this paper found firm size is a main factor influencing for on firm’ innovation activities and long-term performance. In conclusion, the study suggests that in future research scholars should emphasize the explicit process by which firm managers utilize their political ties within the context of transition economies.
This study focused on one political tie, that is, China, and future studies should examines the generalizability of this findings to other emerging countries. Similar to the Chinese government, governments in other emerging countries such as Russia, India and Kenya often provide important financial and political resources through non-transparent way, and taking innovation as one of the national strategic priorities (Magaloni, & Kricheli, 2010).
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R&D and align the tendency of global innovation competitions.
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