Can firms with political connections borrow more than those without? Evidence from firm-level data for Indonesia

Abstract

Using a unique firm-level dataset for the manufacturing sector in Indonesia, we examine how firms’ political connections affect their access to finance and performance. We determine individual firm's political connections by identifying whether the government owns shares in the firm, whether politicians are on its board of directors, and whether highly-ranked managers personally know any politician. Although several studies have examined effects of political connections on firms financing and performance, we contribute to the literature by distinguishing between large firms and small and medium enterprises (SMEs), between the loan approval and amount setting processes, and between formal and informal political connections. We find that politically connected firms are more likely to be able to borrow from state-owned banks. Moreover, being connected to the government raises the probability that a firm can receive the full loan amount it applied for. The improvement in access to finance from political connections is more prominent for SMEs than for large firms. Furthermore, such improvement mostly comes from personal connections with politicians rather than more formal connections measured by the government ownership or politicians on the board of directors. Finally, we examine the effect of political connected lending on allocative efficiency of capital and find weak evidence that scarce financial resources are likely channeled by state-owned banks to politically connected but less productive firms.