Political Connection and Its Implications on Firm Value
Investigating the double-edged sword of political connections: whether it brings privileges or triggers inefficiency and resource tunneling.
In many emerging markets with weak legal institutions, political connection becomes a highly valuable intangible asset. Companies frequently appoint former ministers, generals, or parliament members to their board of commissioners to secure preferential treatment.
The Helping Hand Hypothesis (Benefits)
The first perspective argues that political connection provides tangible benefits. Connected firms find it easier to win government procurement tenders, secure excavation permits or import licenses quickly, receive bailouts during crises, and enjoy access to state-owned bank loans at softer interest rates.
The Grabbing Hand Hypothesis (Inefficiency)
Conversely, the second perspective views political connection as a burden. These companies are often forced to bear government social burdens, such as overemploying staff to suppress unemployment rates. Furthermore, political protection makes management less innovative, neglectful of operational efficiency, and vulnerable to tunneling or rent-seeking practices by the politicians themselves.
Measurement in Research
Researchers typically define a firm as Politically Connected (a 1/0 dummy variable) if at least one member of the Board of Directors, Board of Commissioners, or controlling shareholder holds an active position or has a track record in the government or a political party. The firm value proxy most frequently associated with this variable is Tobin's Q or Market-to-Book Ratio.