Political dynamics, environmental concerns, and corporate governance: Evidence in China

<p dir="ltr">Corporate governance remains a critical topic in corporate finance, particularly in emerging markets like China, where firms operate under a distinct regulatory framework, ownership structure, and institutional environment. One key focus is understanding managerial incentives and establishing effective governance mechanisms, as these factors directly influence corporate decision-making and firm performance, and thereby shareholder wealth. Additionally, the increasing emphasis on environmental sustainability has reshaped traditional business models, pushing firms toward more sustainable practices. Based on China's unique hybrid market conditions, institutional environment, and development pathway, this thesis aims to advance understanding of the interplay between political dynamics, environmental concerns, and corporate governance over three chapters of analysis.</p><p dir="ltr">Chapter 2 examines the political rank of CEOs in Chinese state-owned enterprises (SOEs) and their managerial incentives in pursing innovation. Specifically, it investigates how political promotion influences corporate innovation in SOEs. This chapter proposes that CEOs with political aspirations pursue innovation to advance their political rank, particularly in response to the national innovation policy. The findings reveal that the state is more likely to reward SOE CEOs with political promotions for superior innovation performance, especially when performance metrics are quantifiable. This effect is stronger when CEOs are nearing retirement or are in politically dynamic environments with lower anti-corruption exposure. Therefore, the existence of the political labour market serves as an external governance mechanism that shapes CEOs’ incentives for innovation in SOEs.</p><p dir="ltr">Chapter 3 explores how firms’ environmental responsibility influences managerial incentives through the examination of CEO pay-performance sensitivity. It argues that CEOs may exploit environmental investments to enhance their personal publicity and exposure at the expense of firm profitability, prompting the board to strengthen the link between CEO compensation and firm performance to mitigate agency conflicts and safeguard shareholder wealth. The evidence shows that firms’ environmental investments significantly increase the marginal effect of firm performance on CEO pay, thereby strengthening the sensitivity of CEO compensation to firm performance, particularly in firms exposed to environmental risk or operate in highly-polluting industries. This relationship is driven by insufficient external monitoring of environmental spending, highlighting the need to strengthen internal governance mechanisms, particularly through the design of compensation contracts. Moreover, the effect is weaker for powerful CEOs who also serve as board chairs and hold firm ownership, suggesting the importance of enhanced governance measures to mitigate their influence.</p><p dir="ltr">Chapter 4 builds on Chapter 3 by examining how environmental problems shape external governance; specifically, how air pollution affects analyst coverage. Analysts play a crucial role as monitors and information intermediaries between firms and the markets. This chapter demonstrates that firms located in cities with worse air pollution receive greater analyst coverage due to their weaker information environments, thereby increasing investor demand for analyst services. This effect is moderated by state ownership, as non-SOEs face greater operating uncertainty without state capital guarantees, making the demand for analyst services more sensitive to air pollution. Additionally, analysts covering firms in polluted environments tend to have more industry expertise and focus on fewer firms, owing to the challenges posed by weaker information quality. Overall, the findings from this chapter highlight that increased analyst coverage could serve as an external governance mechanism, helping to mitigate information asymmetry for firms in polluted regions.</p>