Politically Connected Firms and Earnings Informativeness in the Controlling versus Minority Shareholders Context:European Evidence

Abstract

Manuscript Type Empirical Research Question/Issue Focusing on an environment where ownership concentration is prevalent and where the presence of politically connected directors on the board is the natural form of political connection, we analyze the effect of political connections on earnings informativeness. We also examine a question that has not been considered in previous research, namely, the impact of the level of divergence between the dominant owner's voting and cash flow rights on earnings informativeness for politically connected firms. Research Findings/Insights We find that the presence of politicians on the board negatively affects earnings informativeness. We also find a positive impact of the divergence between the dominant owner's voting and cash flow rights on the informativeness of accounting earnings in politically connected firms. Theoretical/Academic Implications We show that the relationship between political ties and earnings informativeness is explained by an information effect, whereby politicians and shareholders are interested in providing as little information to the market as possible in order to protect political ties from public scrutiny and prevent the leakage of competitive advantages to competitors. Additionally, we show that the positive effect of divergence between the dominant owner's voting and cash flow rights on earnings informativeness in firms that belong to a pyramid is explained both by an alignment effect, whereby political connections promote transparency, as well as by a stewardship effect, whereby the ultimate owner of the pyramid, acting as a steward, places politicians on the board to increase the firm's reputation and reports earnings in good faith. Practitioner/Policy Implications The results of our study may be useful to regulators interested in increasing transparency in order to promote a more efficient allocation of resources. In particular, the results suggest that in countries where recent reforms aim to improve investor protection and market confidence, regulators should encourage the disclosure of firm political ties. The results of our study may also be useful to investors, financial analysts and auditors, as they highlight the importance of considering specific features of the corporate governance system when assessing the credibility of accounting information.

Politically connected firms in Spain

“…This approach is consistent with previous literature (e.g., Faccio, 2006;Goldman et al, 2009;Chaney et al, 2011;Boubakri et al, 2012;Duchin and Sosyura, 2012;Bona et al, 2014). As an example, we classify the firm Gas Natural as a politically connected firm in 2012 because at least one of the board members had previously held a leadership position in politics.…”

“…Moreover, Qian et al (2011) find that dominant shareholders' tunnelling and self-dealing activities are more pronounced in politically connected firms when the goal of the connection is to ensure access to bank financing. Chen et al (2011) find that politically connected firms increase information asymmetries, and Chaney et al (2011) and Bona et al (2014) show a lower quality of accounting information in politically connected firms. Additionally, political directors could be an important source of benefits for the company because they provide knowledge on bureaucratic and regulatory procedures (e.g., Agrawal and Knoeber, 2001;Goldman et al, 2009).…”

Board Composition and Accounting Conservatism: The Role of Business Experts, Support Specialist and Community Influentials

“…This preference for fixed‐effects estimation is in line with previous findings that conservatism related to news is more likely to differ at the firm level (Bona Sanchez et al. ).…”

“…However, consistent with an information effect, politically connected firms may prefer to provide as little information to the market as possible to protect the firm's political ties from public scrutiny and prevent the disclosure of competitive advantages (Bona Sanchez et al. ). Empirical evidence supports a lower level of earnings quality for politically connected firms (Riahi‐Belkaoui ; Chaney et al.…”

“…Recently, for Spanish firms, Bona Sanchez et al. () find evidence of a lower level of earnings informativeness for firms with political members on their boards. According to this view, for biotech firms with more community influential directors, accounting conservatism might be reduced to the extent that they prefer opacity.…”