*2.2. Political Connection and the Impact of Overborrowing on Firms' R&D*

One prominent feature of China's banking system is that state ownership is pervasive. This is particularly true for the state-owned commercial banks. State-owned banks, as a worldwide phenomenon, are inevitably accompanied by government intervention and influence [5]. De Haan and Vlahu (2016) and Hopt (2021) provide evidence that the significant influence exercised by the government is accompanied by a negative impact on

the quality of corporate governance in banks as well as on their performance [55,56]. More importantly, it is worth mentioning that firms controlled by the state do not necessarily incur a connection relationship, simply because their shares are controlled by the state according to the Company Law of China (Article 126/2018). There thus exist potential transactions that lead to the transfer of the interest of firms and can be exempted from monitoring and information disclosure. In this context, SOEs have strong incentives to participate in building political connections in order to acquire easier access to bank loans.

The existing viewpoints of a firm's political connections impacting bank governance can be roughly divided into the "signal effect" and "resource effect". From the perspective of the signal effect, access to political connections provides a positive signal about the quality and creditworthiness of focal firms and reduces information asymmetry for private investors [57]. It can reduce a bank's dependence on a focal firm's financial statements and facilitate its access to bank loans [58]. Houston et al. (2014) names it the implicit insurance effect of political connections [59]. From the perspective of the resource effect, having political connections can also enable firms to obtain credit resources, acquire contracts, avoid coercive treatment as well as fines from regulators, acquire fiscal assistance, and enjoy other advantages since the loan granting decisions of state-owned banks will be led by political consideration [60–62]. Many studies have shown that politically connected firms can obtain more bank loans and reduce their financing constraints [63,64]. It is also easier for local bureaucrats to channel funds in the form of loans to firms with which they have connections through banks they control [65].

The promotion tournament is an important incentive mechanism for top management of SOEs in transition economies. Taking further analysis, the role of political connections may be contingent due to different administrative levels. Top managers' cash compensation, equity ownership, and perquisites are usually linked to job titles and position ranks. Lazear and Rosen (1981) show that the pay gap between the CEO and other executives is a reward for the promotion tournament, which stimulates these executives to compete intensively with each other [66]. Moreover, there is a strand of literature on the positive impact of pay dispersion for innovation in China. Jia et al. (2016) find that higher pay gap between CEOs and other executives can promote corporate innovation by attracting talent and reducing excessive board intervention [67]. Xu et al. (2017) examine the pay dispersion between executives and ordinary employees, and find a positive impact on corporate innovation of Chinese listed firms [68]. More importantly, the supervision intensity for bureaucrats or SOEs' "quasi-bureaucrats" managers is closely proportional to their administrative level, too. The lower the level of managers' political connection, the less supervision they are subject to. In the case of strong motives and weak supervision, managers with political connections below the provincial level in SOEs are more inclined to exert their political intervention on loan acquisition. As a result, firms become easily overborrowed. Thus, hypothesis 2 is proposed:

**H2:** *The lower the political connection level of focal firms' top managers, the more significant the mediating effect of overborrowing*.
