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Review of Quantitative Finance and Accounting

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01.08.2016 | Original Research

Political connections, financial constraints, and corporate investment

verfasst von: Chung-Hua Shen, Chih-Yung Lin

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 2/2016

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Abstract

This study investigates whether firms politically connected to the ruling party can mitigate financial constraints and increase their investments. Data on Taiwan-listed companies from 1991 to 2010 are used to answer the preceding issue. Results indicate that firms connected to the ruling party that transitioned into power can mitigate financial constraints, but results do not hold for firms connected to the opposition party that transitioned out of power. Firms connected to both parties have similar results with those connected to the ruling party, but the diminishing effect is weaker than those connected to the ruling party. Results further indicate that financially constrained firms can increase their investment when they have political connections to the ruling party. Finally, firms with strong connections can reduce financial constraints more effectively.

Vorheriger Artikel Sneaking in the back door? An evaluation of reverse mergers and IPOs

Nächster Artikel A comparison of alternative models for estimating firm’s growth rate

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The studies of Sapienza (2004), Charumilind et al. (2006), Claessens et al. (2008), Ferguson and Voth (2008), Francis et al. (2009), Bunkanwanicha et al. (2009), Chow et al. (2012), Hill et al. (2014), and Ding et al. (2014) showed similar results.

For instance, the financial project of the Taiwan High Speed Rail Corporation (THSRC) was obviously supported by the Taiwanese government in 1999. Moreover, the government made a move to take over the management of the THSRC in 2009. The government takeover is expected to facilitate the refinancing of the huge debt of the THSRC (US$11.8 billion) through a consortium headed by the Bank of Taiwan (a state-owned bank). Furthermore, the refinancing program will provide crucial financial relief in the form of lower interest rates and extended repayment periods.

Notably, our findings may be unable to generalize to countries with no state-owned banks, such as the United States.

Xu et al. (2013) used Chinese data and revealed that political connection could reduce investment–cash flow sensitivity, thereby mitigating financial constraints. However, different from our study, they used the cash flow sensitivity to infer the financial constraints.

The studies of Johnson and Mitton (2003), Cull and Xu (2005), Faccio (2006), and Francis et al. (2009) demonstrated similar results.

Studies using the sensitivity of investment to cash flow to verify the existence of financial constraints include those of Hubbard and Kashyap (1992), Gilchrist and Himmelberg (1995), Worthington (1995).

The five criteria are cash flow, long-term debt, cash, dividends, and Q ratios.

In this study, we classified political connections into two categories: connections to the ruling and opposition party. Because the ruling political party controls more resources than the opposition; therefore, firms connected to the ruling party are expected to have more influence on reducing financial constraints than those connected to the opposition.

Notably, the political connection measure used in this study will change over time. We consider a firm to be politically connected only after the connections of top managers are observed and only when connected managers remain in the firm. During the sample periods, 30 non-politically connected firms were reclassified as politically connected firms, whereas five firms were reclassified as non-politically connected firms after the departure of the connected CEO or chairman in our sample. Our results do not change statistically when we exclude these samples.

This political party tendency is similar to the proxy of Chinese political connection of Li et al. (2008), in which CEOs are also members of the Communist Party or deputies to the National People’s Congress. However, our proxy extends to the element of public support.

Faccio (2006), Faccio et al. (2006), Fan et al. (2007), Goldman et al. (2009), and Francis et al. (2009) all considered appointments to political offices, but not appointments to state-owned enterprises.

Claessens et al. (2008) likewise used donations to a Brazilian presidential candidate as the defining element of political connections. However, in the current study, the concept of donation is broader and includes donations to political parties and those made during congressional and presidential elections.

Hereafter, the terms “financially constrained firms” and “constrained firms” are used interchangeably. Similarly, the terms “financially unconstrained firms” and “unconstrained firms” are used interchangeably.

In another setting, we use unobservable threshold values to estimate the model. However, the results are similar to those using zero as the threshold value. The estimated results using unobservable threshold values are not reported but are available upon request.

We also consider the multiple criteria of Kaplan and Zingales (1997) and Whited and Wu (2006) to examine the robustness of our results. However, for brevity, we only show the results of Z(HT) in the following study. The estimated results based on the other two multiple criteria are available upon request.

Our data file includes firms that no longer exist; thus, no survival bias exists.

We also examine the robustness of the results by including firms connected to both parties. The results are statistically the same.

The number of firms with political connections to KMT is deducted from the number of firms connected to DPP, and vice versa. Hence, in all regression estimations, the benchmarks are non-politically connected firms.

The last row of Panel B reports the p values for the null hypothesis that a single investment regime is sufficient to describe the data. The alternative hypothesis is our endogenous switching model. This test is based on likelihood ratio statistics, in which the Chi square distribution can be used for statistical inferences (for details, see Goldfeld and Quandt 1976).

Congressional and presidential candidates must also disclose all donations immediately after the election. This information is available in Taiwan’s Control Yuan (Supervision Office).

For brevity, we only report the results of firms connected to the ruling party. The estimated results of firms connected to the opposition party and to both parties are also supporting our hypothesis and are available upon request.

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Titel: Political connections, financial constraints, and corporate investment
verfasst von: Chung-Hua Shen
Chih-Yung Lin
Publikationsdatum: 01.08.2016
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 2/2016
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-015-0503-7

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