Corporate political connections and the 2008 Malaysian election
Introduction
Prior research shows that firms’ political connections are positively associated with firm value (Bliss and Gul, 2012, Boubakri et al., 2012, Faccio, 2006, Fisman, 2001, Johnson and Mitton, 2003). Li and Zhang (2007) show how managers’ functional experience and their political network help to enhance performance of new ventures (also see Lester, Hillman, Zardkoohi, & Cannella, 2008). A natural question that arises is whether political connections continue to be as important for firms during later periods as they are in initial periods. Accordingly, we examine the following two research questions: (a) Is the relationship between firms’ political connection and firm value different for firms with political connections for longer and shorter periods? (b) What is the mechanism that drives the differential relationship?
We draw on institutional theory in sociology to develop the hypothesis that the relationship between political connections and firm value is moderated by the length of time over which firms are politically connected (see Rona-Tas, 1994). Specifically, we posit that compared to firms that are politically connected for a short period of time, firms that are politically connected for a long period of time are more likely to have built their credibility of adherence to government policies which allows them access to the informal political elite network (DiMaggio and Powell, 1983, Donaldson, 2008, Sanders and Tuschke, 2007). This in turn would enable them to obtain important economic resources such as talented managers and become more self-sustaining. Thus, we expect firms with political connections for a long period to be less severely affected by the loss of political power by the ruling party (in terms of their supermajority) than firms with political connections for a short period.
We examine this hypothesis in the 2008 Malaysian General Election setting where the ruling party – the National Front or Barisan Nasional (BN) – unexpectedly lost their longstanding supermajority. To identify politically connected firms, we update the list provided by Johnson and Mitton (2003) and Faccio, Masulis, and McConnell (2006). Firms that are identified as politically connected in both 1997/1998 and 2007 are classified as firms with political connections for a long period (referred to as old-politically connected firms); and firms that are politically connected only in 2007 are classified as firms with political connections for a short period (referred to as new-politically connected firms). In particular, we identify 122 politically connected firms out of which 39 are new-politically connected firms.
Consistent with our hypothesis, we find that the magnitude of negative stock market reaction to the ruling party’s election loss of supermajority is less for the old-politically connected firms than the new-politically connected firms. To examine the mechanism through which the old-politically connected firms insulate themselves from the adverse consequences of the loss in supermajority power by the ruling party, we investigate the change in board of director characteristics and senior executive characteristics over ten years across old- and new-politically connected firms. We find that the old-politically connected firms become more professional than the new-politically connected firms. Interestingly, we find that changes in board professionalism exhibits improvement for old-politically connected firms over the ten years, but executive professionalism does not. Furthermore, we find that the negative stock price reaction to the election result is attenuated for those old-politically connected firms who show improvements in professionalism, and not for those who do not show such improvements. While, this evidence provides insight into the mechanism through which political connections enhance value, the access to managerial talent that old-politically connected firms develop can by itself help them to continue to extract rents even when the direct benefits of political connection are removed. As such, this evidence could be interpreted as a form of cronyism as well.
Lastly, we attempt to address whether the improvements in board professionalism could be related to cronyism, by examining the subsequent accounting and stock market performance. In particular, we consider return on assets and annual stock return for the three years subsequent to 2008 for the old- and new-politically connected firms. We find that compared to the non-politically connected firms, the accounting and stock market return performance are worse for both the old- and new-politically connected firms; but less so for the old-politically connected firms than the new-politically connected firms. This provides additional evidence that while old-politically connected firms are more self-sustaining than the new-politically connected firms, both of them exhibit worse performance than non-politically connected firms.
The remainder of the paper is organized as follows: First we provide the background literature and the research question; second, we describe the Malaysian context and the General Election in 2008, and develop the hypotheses; third, we present the empirical analysis; and finally, we provide some concluding remarks.
Section snippets
Background and research question
The institutional view is based on the premise that organizations adopt structures in response to their institutional environments and hence is an important theoretical lens in international business (see Carpenter and Feroz, 2001, DiMaggio and Powell, 1983, North, 1990, Peng et al., 2009, Peng et al., 2008, Wan and Hoskisson, 2003). Specifically, firms’ operations and management practices are bound by formal and informal country-specific institutions (see Ingram & Silverman, 2002). The formal
Classifying politically connected firms
To identify politically connected firms (PCONN), we start with the list of PCONN firms provided by Johnson and Mitton (2003) and Faccio (2006) (hereafter referred to as the JM_F List). In addition to the JM_F List, several new firms with political connections have emerged under the patronage of the ‘new political establishment’ such as Kamaludin Abdullah, the son of Abdullah Badawi (Barrock, 2007). We use the news reports in a leading Malaysian business newspaper, The Edge to identify firms
Market reaction to the General Election results for Old- and New-PCONN firms
Table 1, Panel A provides the mean cumulative abnormal returns (CARs) for the PCONN firms (N = 122) and non-PCONN firms (N = 834), as well as for the Old-PCONN (N = 83) and New-PCONN (N = 39) firms, over different windows surrounding the General Election result announcement date, i.e., March 10, 2008. While the mean CAR for the event windows (−1, +1), (−1, +3) and (−1, +5) are not significantly different from zero for the non-PCONN firms (e.g., t-statistic = 0.63 for the window −1, +1), the mean CAR of
Conclusion
In this study, we examine whether firms with political connections for a long period suffer less than firms with political connections for a short period as a result of the loss of supermajority by the ruling Malaysian party, in the General Election of 2008. We hypothesize that those firms with political connections for a long period will become more self-sustaining and thus will be less adversely affected by the ruling party’s loss of political power. Consistent with this hypothesis, we find
Acknowledgements
The authors would like to thank Robert Bloomfield (the editor), Eli Bartov, Andrew Ferguson, Ira Horowitz, Bin Ke, Chung-Ki Min, Mian Mujtaba, Bin Srinidhi, Laura Starks, Nancy Su, Ross Watts, Steven Wei, Donghui Wu, Wayne Yu, workshop participants at The Hong Kong Polytechnic University and Journal of Contemporary Accounting and Economics Symposium (2010) for their useful comments. The work described in this paper was partially supported by a Grant (ZV3J) from the Hong Kong Polytechnic
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