Politically induced board turnover, ownership arrangements, and performance of SOEs

• Published date: 01 May 2018
• DOI: http://doi.org/10.1111/corg.12238
• Author: Sotirios K. Bellos,Tanja Kuzman,Oleksandr Talavera
• Date: 01 May 2018

EMPIRICAL

Politically induced board turnover, ownership arrangements,

and performance of SOEs

Tanja Kuzman

1

|Oleksandr Talavera

2

|Sotirios K. Bellos

3

1

Management School, University of Sheffield,

Conduit Road, Sheffield S10 1FL, UK

2

School of Management, Swansea University,

Bay Campus, Swansea SA1 8EN, UK

3

International Faculty‐CITY College,

University of Sheffield, Leontos Sofou 3,

Thessaloniki 546 26, Greece

Correspondence

Tanja Kuzman, Management School,

University of Sheffield, Conduit Road,

Sheffield S10 1FL, UK.

Email: tkuzman1@sheffield.ac.uk

Abstract

Manuscript Type: Empirical

Research Question/Issue: This study investigates the impact of elections on board

member changes and its relationship with profit‐oriented performance of state‐

owned enterprises (SOEs), thus providing new insights on political tie heterogeneity.

Research Findings/Insights: Using a unique hand‐collected dataset of 200 SOEs in

six countries of the former Socialist Federal Republic of Yugoslavia (SFRY) from 2010

till 2014, we find that board member changes within SOEs, unlike for private enter-

prises, are politically motivated rather than performance induced. We reveal that

SOEs with higher levels of board member changes encounter lower productivity

and profitability levels. These findings suggest that political interference via board

member changes causes organizational inefficiencies and poor SOE performance.

Moreover, the results show that board member changes are insignificant for the per-

formance of large SOEs and SOEs governed by independent government body.

Theoretical/Academic Implications: This study reveals an indirect channel for polit-

ical interference, thus contributing to a better understanding of political tie heteroge-

neity. Moreover, our study is the first to link political interference and performance of

SOEs through introduction of election cycles into the board member changes–perfor-

mance relationship.

Practitioner/Policy Implications: The results of this study provide insights for

policymakers who are interested in enhancement of SOEs' performance. They suggest

ways in which board appointment procedures should be altered as to be insulated

from political interference. In addition, they show boards how they can lower the neg-

ative consequences of frequent board member changes.

KEYWORDS

Corporate governance, election cycles, ownership arrangement, performance of SOEs, politically

induced board turnover

1|INTRODUCTION

The political view of state ownership asserts that political ties are

established through appointments of politically like‐minded individuals

or bureaucrats that follow certain political interests (Boycko, Shleifer,

& Vishny, 1996). The primary goal of these appointees is fulfillment

of their personal and/or political interests that are not in line with

the enterprise value maximization objective (La Porta, Lopez‐de‐

Silanes, Shleifer, & Vishny, 2002; Shleifer & Vishny, 1994, 1997).

Moreover, these appointees might lack the appropriate knowledge,

competences, and experience for carrying out board responsibilities

(Vagliasindi, 2008; World Bank, 2014). In that way, governments

Received: 2 October 2016 Revised: 13 February 2018 Accepted: 15 February 2018

DOI: 10.1111/corg.12238

160 © 2018 John Wiley & Sons Ltd Corp Govern Int Rev. 2018;26:160–179.wileyonlinelibrary.com/journal/corg

constitute boards of state‐owned enterprises (SOEs) to ensure that

they fulfill their interests even when this may cause negative perfor-

mance (World Bank, 2014).

The main focus of the past empirical research on this topic is

related to personal level political ties and government ownership ties

within SOEs. Researchers use political connections of CEOs (e.g.,

Wu, Wu, Zhou, & Wu, 2012), percentage of politicians/government

officials on boards (e.g., Menozzi, Gutierrez Urtiaga, & Vannoni,

2011; Okhmatovskiy, 2010), or unlawful discharge of a board chair-

man or CEO (e.g., Ding, Jia, Wu, & Zhang, 2014) as political interfer-

ence proxies. These proxies neglect the existence of political tie

heterogeneity. Sun, Mellahi, Wright, and Xu (2015) explain that past

research has failed to recognize the informal linkages that might exist

between business people and politicians. Therefore, the main ques-

tion is whether political interference goes beyond the establishment

of formal political ties and, if so, what kind of informal channels

might exist.

Vickers and Yarrow (1988) suggest that for SOEs, board member

changes comply with political rather than market forces. Government

officials and political appointees are replaced whenever a new gov-

ernment representative or ruling political party is elected (Kernaghan,

1986). In that way, political establishments distance themselves from

individuals connected to the previous political administration (Sun

et al., 2015), who are unlikely to show loyalty and impartiality for

the new political party in power (Kernaghan, 1986). Consequently,

board member changes are triggered by election cycles, which thus

represent a hidden channel for political interference. In addition,

board members without direct political ties could suffer from “guilt

by association”. This refers to punishment of individuals or organiza-

tions because of their prior relationship with illegitimate, disadvan-

taged, or undesirable individuals or networks (Labianca & Brass,

2006). Hence, even non‐politically connected board members might

be replaced.

Politically induced board member changes might indicate that

the likelihood of board member discharge due to poor performance

is much lower for SOEs. Nevertheless, political interference via

board member changes may lead to operational inefficiencies and

poor SOE performance. The lack of perfect substitution for individ-

ual board members creates a time lag before an efficient decision‐

making process is re‐established (Sharma, 1985). Moreover, new

board members need time to adapt in order to be able to positively

contribute to the decision‐making process (Smith et al., 1994). Rec-

ognizing that performance depends on board decisions, politically

motivated board member changes might have negative effects on

SOE performance. The magnitude of these effects could be influ-

enced by the interplay of the SOE's political importance and the

government ownership ties.

In this study we examine the relationship between election cycles

and board member changes and we analyze how that relationship

impacts the performance of SOEs in six countries of the former Social-

ist Federal Republic of Yugoslavia (SFRY): Bosnia and Herzegovina,

Croatia, FYR Macedonia, Montenegro, Serbia, and Slovenia. Our

hand‐collected dataset has financial and board member information

for 200 SOEs from 2010 to 2014. We examine the relationship

between elections and board member changes and between board

member changes and performance using panel data fixed effects and

a panel data instrumental variable (IV) estimator, respectively.

There are several reasons to motivate investigation of SOEs in

countries of the former SFRY. First, these countries had similar legal

frameworks, market rules and ways in which they govern state owner-

ship (Horvat, 1971). Coherent patterns could be depicted by looking

at the level of state ownership, their number, and the sectors in which

they operate (Bicanic, 2010). Even though each of these countries

chose its own path after achieving independence, all of them still face

similar problems (e.g., level of indebtedness, staggered economic

activity, political instability). Second, in spite of privatization efforts

during the past 20 to 30 years, the degree of state ownership in

these countries is still high. Despite the fact that absolute numbers

of SOEs in each of these countries might indicate that the degree of

state ownership is quite distinctive, when we take into account the

employment percentage for which SOEs are accountable, similarities

become apparent.

1

Third, our data reveal that countries within our

sample have analogous levels of board member changes. Therefore,

the six countries of the former SFRY provide a unique set‐up for

examining the influence of board member changes on performance

of SOEs.

The results show that board member changes within SOEs are

politically motivated rather than performance induced. We also

uncover the hidden channel of political interference via board mem-

ber changes. Furthermore, we find a negative and significant rela-

tionship between politically induced board member changes and

performance of SOEs. The relationship is stronger for operating

than for financial performance. Our estimates also indicate a

greater presence of political interference in small‐and medium‐

sized SOEs. Additionally, we reveal that board member changes

are insignificant for the performance of SOEs governed by indepen-

dent government body.

This research contributes to the existing literature in several

important respects. First, we respond to a recent call by Grosman,

Okhmatovskiy, and Wright (2016) to fill in the gap regarding the

nature and drivers of board turnover within SOEs. We offer a detailed

analysis and empirical evidence for Vickers and Yarrow's (1988) theo-

retical standing that board member changes within SOEs comply with

election cycles (political force) rather than poor performance results

(market force). Second, we introduce politically induced board member

changes as a new proxy for political interference within SOEs. With

this proxy we recognize that political interference goes beyond per-

sonal political ties of CEOs, board chairmen, or a portion of board

members, and takes into account the dynamics of the entire board.

Third, we complement research studies on the political view of state

ownership (e.g., Krueger, 1990; Shleifer & Vishny, 1997) and the polit-

ical embeddedness perspective (e.g., Michelson, 2007) with our novel

empirical approach to political interference. More specifically, we

investigate the link between political interference and performance

of SOEs by introducing the election cycles into the board–perfor-

mance relationship. Fourth, we contribute to the literature about the

factors that influence SOE performance. We show that political inter-

ference via unstable board membership engenders poor performance.

Frequent board member changes disrupt board dynamics, thus creat-

ing numerous operational inefficiencies (Sharma, 1985). Finally, our

EMPIRICAL 161