Product competition, political connections, and the costs of high leverage

Abstract

This paper explores whether the political connections of listed firms in China affect the costs of high leverage on a firm's product competition. We collect a sample of 1341 non-state-owned firms (i.e., private firms) with political connections listed in the Chinese stock market from 2009 to 2019. Using the sensitivity of sales growth to high leverage to proxy for the costs of high leverage, we find that the negative effect of high leverage on sales growth is significantly lower for companies with political ties. Our results are robust to a series of endogeneity corrections and robustness checks. We also find that political connections benefit highly leveraged firms by reducing the adverse behavior of customers and competitors. However, the effect of political connections on the unfavorable actions of employees and suppliers is not statistically significant. In addition, the mitigating effect of political connections on high leverage costs is more pronounced in firms with low profitability, headquartered in low-trust provinces, and experiencing high economic policy uncertainty. Finally, we find that political connections can also mitigate the negative effect of high leverage on firms’ investment and profit. Overall, our findings suggest that political connections reduce the cost of high leverage.