emerging literature on financial constraints in China. Our paper confirms some results from that literature in that we also find that Chinese firms face financial constraints, but state-and foreignowned firms tend to face less severe ones (Chow and Fung 1998, 2000; Chen 2008; Herícourt and Poncet 2009; Poncet, Steingress, and Vandenbussche 2010; Guariglia, Liu, and Song 2011). We differ from those studies in that (a) we provide direct tests of how financial constraints vary with CEOs’ connections to the state,<sup>7</sup> (b) we provide a simple model that explicitly shows how government connections could affect investment-cash-flow sensitivity and investment levels, (c) we show that government connections matter for financial constraints and investment within the sub-sample of non-state firms, (d) we provide robust evidence that large non-state firms without government connection tend to be most severely constrained among firms of all sizes, and (e) we use a more representative sample of Chinese firms.<sup>8</sup> We also differ slightly in terms of methodology in that we look at both investment-cash-flow sensitivity and investment sensitivity to access to external finance.

7 Chan et al. (2011) also examine political connections and financial constraints, and find that connected firms are less constrained. We differ from them in the following ways. First, they use only listed firms, which are large firms that are likely to face the least severe financial constraints. Second, their measure of political connection is whether the CEO/Chairman was a government official, a military officer or someone with a political ranking at the provincial or ministerial level, while ours is whether the CEO was appointed by the government. Thus their measure represents a very specific connection related to provincial level political ranking, while our measure represents government connection at all levels for all types of firms. Third, our sample is more representative, and thus we can examine how the effects of political connections on financial constraints differ across firm sizes. Fourth, we examine how political connections are associated with investment levels and CEO incentives. Fifth, we offer a simple theoretical model that spells out explicitly how government connections affect a firm’s investment and investment-cash-flow sensitivity. Finally, we provide a more comprehensive set of robustness checks. 8 Chow and Fung (1998, 2000) use a panel of manufacturing firms operating in Shanghai over the period 19891992. Héricourt and Poncet use data from 1300 firms from 2000 to 2002. Chen (2008) used listed firms, which are largely state-owned (see Wang, Xu and Zhu 2004) and arguably are less financially constrained than typical Chinese firms. Poncet, Steingress, and Vandenbussche (2010) use a sample of 22,300 observations from 15,000 large firms from 1998 to 2005. Those firms had at least 150 employees, US$10 million in annual sales turnover, and/or US$20 million in total assets. Similarly, Guariglia, Liu, and Song (2011) a data set with more firms than ours, but that covers large and medium-sized private firms (and all SOEs), and thus is not suited to assessing the financial constraints of small, young firms, which is a point of emphasis in what follows.

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