Political connections, bailout in financial markets and firm value

Abstract

The paper shows that politically motivated interventions in the financial market in the form of bailing out borrowing firms reduce banks' incentives to gather valuable information about firms' projects. This loss of information is a hidden cost which adversely affects firm value. Firms invest resources and pay a premium to politically connected persons (BOD or other personnel). Such connections serve the twin purposes of hedging and enhancement of the value of collateral pledged against bank loans. Feeling secured, banks lose incentives to monitor borrowing firms. Thus, wealth effect of bailout from political connection is partially offset by the losses of valuable information brought about by bank lending. In equilibrium, the trade-off from gains out of political connections and costs due to losses from informationbased bank monitoring depend on (i) the country's disclosure laws, (ii) the political environment, (iii) the premium paid to form connections, and (iv) the state of the economy.

Political connections and household access to bank loans: evidence from China

“…Therefore, households' subjective beliefs of why they were not granted bank loans can be ascribed to either poor economic conditions (i.e., income, collateral) or poor social relationships (i.e., guarantees from others, relationships with loan officers). The latter explanation is consistent with results from previous studies of social capital, showing that borrowers who are more engaged in social activities and have broader social networks are more likely to be granted bank loans (Banerji et al, 2018;Dong et al, 2016;Dufhues, Buchenrieder, & Munkung, 2013;Feng et al, 2015;Okten & Osili, 2004;Wydick et al, 2011).…”

“…Feng et al (2014) focus on Chinese listed firms; they find that political connections contribute to firms' post-IPO stock values and accounting performances. These outcomes help explain why firms are encouraged to actively develop political connections (Banerji, Duygun, & Shaban, 2018;Dong, Wei, & Zhang, 2016;Feng et al, 2015;Yueh, 2009).…”

“…Regular participation in political activities enhances their opportunities to cultivate close relationships with party members such as bank officials. Frequent contacts facilitate mutual trust and eliminate information asymmetry problems between households and loan officers, thereby increasing the households' probability of getting loans (Banerji et al, 2018;Cole, 1998;Dong et al, 2016;Feng et al, 2015). Therefore, because politically connected households may be more motivated to apply for bank loans, we derive the following hypothesis: H1: Households with political connections having demand for bank loans are more likely to apply for loans than households without such connections.…”

The impact of water information disclosure on the cost of capital: An empirical study of China's capital market

“…At present, the mainstream view of the relationship between political connection and capital costs is Government favouritism (Chen, Henderson, & Cai, 2017), the idea that establishing political connections and maintaining close ties with the Government helps businesses to get credit facilities, tax breaks, financial subsidies and financial resources (Cull, Li, Sun, & Xu, 2015;Li & Xie, 2014;Li & Zhou, 2015;Song, Feng, & Tan, 2014;Thompson & Toledo, 2016;Tian & Zhang, 2013). Banerji, Duygun, and Shaban (2016) argued that political connections are everywhere, and that their role depends mainly on the political, economic and legal settings of each country, especially in many emerging market countries. As more and more banks are becoming nationalized, firms with political connections are thought to have higher collateral value in banks (Zhang, Li, Zhou, & Zhou, 2014).…”

The Diplomacy Discount in Global Syndicated Loans

“…See, e.g.,Fisman (2001),Butler, Fauver, and Mortal (2009),Goldman, Rocholl, and So (2009), andBanerji, Duygun, and Shaban (2016).…”