Political connections, legal environments and firm performance around the world

Abstract

AbstractTheoretically, political connections may be a double‐edged sword to a firm. On the one hand, political connections may help the firm to reduce the policy risk and access to more critical resources. On the other hand, political connections may introduce the government or politicians as influential stakeholders who may impose their own interests on other stakeholders and cause multiple agency conflicts. Although there are many studies have investigated the effects of political connections on firm performance in single countries, the worldwide effects of political connections are still ambiguous. Moreover, whether the value and costs of political connections are contingent on legal systems, regulatory institutions and industry characteristics are also under‐explored. By using a sample covers 49 countries and 151,475 firm‐year observations, we find that firms with financial constraints, firms in heavily regulated industries, and firms in countries with worse legal environment or shareholder protection mechanism are more likely to establish political connections. We further find that political connections have an adverse net effect on the firm's operating performance as well as the firm value. This adverse effect is especially pronounced if a firm is in heavily regulated industries. However, the cost of rent‐seeking activities involved in political connections can be restrained in a better legal system or by a better shareholder protection mechanism, thus significantly mitigating the adverse effect.