Politically Connected Firms Research Articles

The economics of politically-connected firms

Political connections between firms and autocratic regimes are not secret and often even publicly displayed in many developing economies. We argue that tying a firm’s available rent to a regime’s survival acts as a credible commitment forcing entrepreneurs to support the government and to exert effort in its stabilization. In return, politically-connected firms get access to profitable markets and are exempted from the regime’s extortion. We show that such a gift exchange between government and politically-connected firms can only exist if certain institutional conditions are met. In particular, the stability of the regime has to be sufficiently low and the regime needs the power to exploit independent firms. We also show that building up a network of politically-connected firms acts as a substitute for investments in autonomous stability (such as spending on military and police force). The indirect strategy of stabilizing a regime via politically-connected firms gradually becomes inferior when a regime’s exploitative power rises.

The Economics of Politically Connected Firms

Political connections between firms and autocratic regimes are not secret and often even publicly displayed in many developing economies. We argue that tying a firm's available rent to a regime’s survival acts as a credible commitment forcing entrepreneurs to support the government and to exert effort in its stabilization. In return, politically-connected firms get access to profitable markets and are exempted from the regime's extortion. We show that such a gift exchange between government and politically-connected firms can only exist if certain institutional conditions are met. In particular, the stability of the regime has to be sufficiently low and the regime needs the power to exploit independent firms. We also show that building up a network of politically-connected firms acts as a substitute for investments in autonomous stability (such as spending on military and police force). The indirect strategy of stabilizing a regime via politically-connected firms gradually becomes inferior when a regime's exploitative power rises.

Do Lenders Favor Politically Connected Firms? Rent Provision in an Emerging Financial Market

Corruption by the politically connected is often blamed for economic ills, particularly in less developed economies. Using a loan-level data set of more than 90,000 …rms that represents the universe of corporate lending in Pakistan between 1996 and 2002, we investigate rents to politically connected …rms in banking. Classifying a …rm as “political”if its director participates in an election, we examine the extent, nature, and economic costs of political rent provision. We …nd that political …rms borrow 45 percent more and have 50 percent higher default rates. Such preferential treatment occurs exclusively in government banks - private banks provide no

Political Connections and Corporate Bailouts

We analyze the likelihood of government bailouts of a sample of 450 politically-connected (but publicly-traded) firms from 35 countries over the period 1997 through 2002. We find that politically-connected firms are significantly more likely to be bailed out than similar non-connected firms. Additionally, politically-connected firms are disproportionately more likely to be bailed out when the IMF or World Bank provide financial assistance to the firm's home country. Further, among firms that are bailed out, those that are politically-connected exhibit significantly worse financial performance than their non-connected peers at the time of the bailout and over the following two years. This evidence suggests that, at least in some countries, political connections influence the allocation of capital through the mechanism of financial assistance when connected companies confront economic distress. It may also explain prior findings that politically-connected firms borrow more than their non-connected peers.

Do Lenders Favor Politically Connected Firms? Rent Provision in an Emerging Financial Market

Corruption by the politically connected is often blamed for economic ills, particularly in less developed economies. Using a loan-level data set of more than 90,000 firms that represents the universe of corporate lending in Pakistan between 1996 and 2002, we investigate rents to politically connected firms in banking. Classifying a firm as political if its director participates in an election, we examine the extent, nature, and economic costs of political rent provision. We find that political firms borrow twice as much and have 50% higher default rates. Such preferential treatment occurs exclusively in government banks - private banks provide no political favors. Using firm fixed effects and exploiting variation across time or lenders, we show that the observed political preference is driven by the political status of the firm and not by any unobserved firm characteristic. The political rents thus identified increase with the strength of the firm's politician and whether he or his party is in power, and fall with the degree of electoral participation in his constituency. We provide direct evidence that rules out alternative explanations such as socially motivated lending by government banks to politicians. The economy wide costs of the rents identified are estimated to be 0.3% to 1.9% of GDP every year.

Politically-Connected Firms: Can They Squeeze the State?

For a sample of 42 countries, I examine firms whose controlling shareholders and top managers are members of national parliaments or governments. I find that this overlap is quite widespread, especially in highly corrupted countries. Connected companies enjoy easier access to debt financing, lower taxation, and stronger market power. These benefits increase when companies are connected through their owner, with a minister, or a seasoned politician. Furthermore, these benefits are generally larger when the firm operates in a country with high corruption, low protection of property rights, a highly interventionist government, or a non-democratic government. Even though these connections provide significant benefits, connected firms under-perform their peers on an ex-ante basis. Therefore connections, by driving benefits to relatively poorly performing firms, distort the allocation of funds and investment decisions.