This paper examines whether a government can play an important role in determining a firm’s related party transactions associated with tunnelling. Through the lens of political turnover in 31 Chinese provinces for 2000-2018, we show that political turnover is negatively associated with state-owned enterprises’ (SOEs’) related party transactions (RPTs) but has no impact on non-SOEs’. Political turnover engenders uncertainty to SOEs, which curtail tunnelling-related RPTs. We identify two channels – corruption and policy-induced RPTs – leading political turnover to reduce RPTs. Corruption RPTs fall more significantly in highly corrupt provinces and before the 2012 anti-corruption campaign. Policy RPTs of SOEs with delisting risk and in high public debt provinces decrease considerably. Financially constrained firms, older officials and within-province appointments diminish the impact of political turnover on RPTs. On average, the fall in RPTs starts a year before a political turnover and ends a year after.

China’s listed companies often exchange corporate assets with their unlisted affiliates such as parent companies, which is rarely observed in their American counterparts. We find that listed companies which are incompletely restructured from former state-owned enterprises tend to exchange more profitable assets for less profitable assets (i.e., tunneling). However, when there is a need to avoid reporting losses and to raise additional capital, listed companies tend to exchange less profitable assets for more profitable assets (i.e., propping). We also find that the market reacts indifferently to assets exchange announcement. Finally, we find that assets exchange with tunneling (propping) incentive is associated with detrimental (improved) post-exchange stock performance and financial performance. In summary, this study contributes to the corporate assets literature by providing two new incentives (tunneling and propping).

Friedman et al. (2003) developed a model in which, in equilibrium, controlling shareholders may choose either tunneling or propping depending on the magnitude of an adverse shock and the magnitude of the private benefits of control. In this paper, we employ connected transaction data from China to test the implications of their model. We hypothesize that, when listed companies are financially healthy (in financial distress), their controlling shareholders are more likely to conduct connected transactions to tunnel (prop up) their listed companies and the market reacts unfavorably (favorably) to the announcement of these transactions. Our empirical findings strongly support our hypotheses. Our analysis supports Friedman et al.’s (2003) model by furnishing clear evidence that it is possible that propping and tunneling might occur in the same company but at different times.