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

Abstract

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 45 percent more and have 50 percent higher default rates. Such preferential treatment occurs exclusively in government banks-private banks provide no political favors. Using firm fixed effects and exploiting variation for the same firm across lenders or over time allows for cleaner identification of the political preference result. We also find that political rents 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 against 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 percent of GDP every year. Copyright (c) 2005 Massachusetts Institute of Technology.

Does political capital create value in the IPO market? Evidence from China

“…For the first time, we empirically document that the IPO applications of firms with political capital are more likely to be approved by regulators, which means that political capital also facilitates access to the IPO market. Previous studies have shown that connected firms have easier access to bank loans (e.g., Khwaja and Mian, 2005;Faccio, 2006;Faccio et al, 2006;Claessens et al, 2008). We complement these studies by showing that connected firms are also better able to access funds in the public equity market.…”

“…2 See Li et al, 2008. 3 See, for examples, Khwaja and Mian, 2005;Adhikari et al, 2006;Agrawal and Knoeber, 2001;Claessens et al, 2008;Faccio, 2006;Faccio et al, 2006;and Li et al, 2008. 4 See Chaney et al, 2011;and Berkman et al, 2010.…”

A Recent Literature Review on Corporate Political Connections

“…Pioneered by Khwaja and Mian (2005), A substantial number of papers have empirically investigated the difference in access to finance between politically connected and politically connected firms. Consistently, in this review, there are 8 papers that specifically address this issue.…”

The politician and his banker — How to efficiently grant state aid

“…7 Remarkably, about 25 per cent of the loans from public banks are granted by banks that explicitly have social objectives. Interestingly, these banks are not used to favor politically connected firms (Khwaja and Mian, 2005). Moreover, after the deregulation of the French banking sector that started in 1985, bank debt declined sharply, especially for poorly performing firms which, as a consequence, were more likely to exit (Bertrand, Schoar, and Thesmar, 2007).…”

“…These studies also point out the important role the electorate plays in monitoring politicians by showing, for instance, that the rents granted by politicians decrease if electoral participation increases (Sapienza, 2004;Khwaja and Mian, 2005;Cole, 2009). None of the studies, however, compares the costs of granting subsidies through a public bank with other means of subsidization.…”