The Effects of Political
Connections on Finance
and Banking
IRWAN TRINUGROHO
SBM ITB
FEBRUARY 9, 2016
2
Political Influences on Business: Anecdotal
Evidence Worldwide (Faccio, AER, 2006)
 Connections with Members of Parliament (e.g. Lord
Browne of Maddingley, a member of the British House of
Lords, is the CEO of British Petroleum)
 Connections with a Minister or Head of State (e.g.
Italy's Prime Minister Silvio Berlusconi is a large
shareholder of four Italian listed firms: Arnoldo
Mondadori Editore, Mediaset, Mediolanum, and Stand)
 Companies Closely Related to a Top Official (e.g.
members of the UMNO party in Malaysia)
Political Influences on Business
 The rent seeking theory (Krueger, 1974)
 The grabbing hand theory (Shleifer and Vishny,
1994, 1998)
 Politically connected firms
Political Influences on Business
Bribes
Businessmen
Bureaucrats/
Politicians
Privileges
5
Routes and Forms of political connections
 Routes of engagement: politicians initiate corporate,
or corporate offers some stake to politicians
 Form of connection: control devices (ownership,
involvement in management and on the board) and
political campaign contribution
Benefits of political connections
 Easier access to financial resources (Charumilind et al.,
2006; Claessens et al., 2008; Fraser et al., 2006; Khwaja and
Mian, 2005; Li et al., 2008)
 Higher probability of being bailed out (Faccio et al., 2006)
 Increase in firm value (Fisman, 2001; Goldman et al., 2009)
 Build up confidence in the legal system (Li et al., 2008)
 Improved performance (Johnson and Mitton, 2003)
 Lower cost of equity capital (Boubakri et al., 2012)
 Higher market power (Mobarak and Purbasari, 2006,
Trinugroho, 2016)
 Perceived less risky (Nys et al., 2015)
Disadvantages of being politically
connected
 Lower quality of accounting information reported
(Chaney et al., 2011)
 Lower qualifications of appointed managers and
directors (Boubakri et al., 2012; Leuz and OberholzerGee, 2006)
 Decrease in long term performance (Claessens et al.,
2008; Fan et al., 2007)
 Higher cost of debt (Bliss and Gul, 2012)
 Increasing audit fees (Gul, 2006; Wahab et al., 2009)
Political Connections in Indonesia: Some
Empirical Evidence
 Estimating the value of political connections (Fisman, AER,
2001)
 Political connections, bank deposits, and formal deposit
insurance (Nys, Tarazi, Trinugroho, JFS, 2015)
 Politically Connected Banks: Some Indonesian Evidence
(Sutopo & Trinugroho, EB Forthcoming 2016)
 Political Connections and Market Power: Evidence from
Indonesia (Trinugroho, working paper 2016)
Estimating the value of political
connections
 How much do connections matter?
 To measure the value of connections, Fisman uses a
string of rumors about former Indonesian President
Suharto's health during his final years in office
 In every case, the returns of shares of politically
dependent firms were considerably lower than the
returns of less-dependent firms
 Well-connected firms will suffer more, relative to
less-connected firms, in reaction to a more serious
rumor
Political connections, bank deposits, and
formal deposit insurance
 The impact of banks’ political connections on their ability
to collect deposits under two different deposit insurance
regimes (blanket guarantee and limited guarantee)
 Politically connected banks are able to attract deposits
more easily than their non-connected counterparts, after
the implementation of formal deposit insurance with
limited coverage
 Formal deposit insurance might have improved market
discipline, but it has also exacerbated the issue of political
connections in the banking sector
Expected Sign
Supply Deman
eq.
d eq.
Model
Supply (Dep. Demand (Dep.
Variable:
Variable:
LNDEP)
INTDEP)
12.82***
(0.000)
Constant
LNDEP
-
INTDEP
+
SBPOL
+
PBPOL
+
LG
+/-
SBPOL*LG
+
PBPOL*LG
+
-2.590***
(0.000)
1.448***
(0.000)
0.744***
(0.000)
1.213**
(0.000)
-0.086***
(0.000)
Supply
Demand
12.83***
(0.000)
1.169***
(0.000)
-0.083***
(0.000)
-0.355*
(0.070)
1.341***
(0.000)
0.681***
(0.000)
0.128***
(0.000)
0.429***
(0.000)
0.135***
(0.000)
Politically Connected Banks: Some
Indonesian Evidence
 The impact of being politically connected on
bank performance and cost of funding
 Political connections improve bank
performance
 Also, politically connected banks are
benefited by getting a lower cost of funding
 Political connections are less valuable for
foreign banks
Political Connections
State-owned Banks
Return on Assets
1
2
1.013***
(0.000)
1.554***
(0.000)
Return on Equity
3
4
9.707***
(0.000)
16.363***
(0.000)
Interest on Deposits
5
6
-1.841***
(0.000)
-2.728***
(0.000)
0.703***
(0.000)
0.030***
(0.000)
0.409***
(0.001)
0.117***
(0.000)
0.047*
(0.055)
-0.594***
(0.000)
0.480**
(0,016)
-0.283
(0.193)
5.885***
(0.000)
0.216***
(0.000)
3.981***
(0.000)
-0.133
(0.132)
0.077
(0.686)
-3.546***
(0.000)
-2.332
(0,133)
10.455***
(0.000)
-1.310***
(0.000)
0.004
(0.818)
-0.044
(0.874)
-0.040*
(0.097)
0.147***
(0.000)
-1.052**
(0.018)
-1.240
(0.174)
7.521***
(0.000)
Private Politically Connected
Banks
Diversification
Lerner Index
Equity to Total Assets
Net Interest Margins
Listed Banks
Foreign Banks
Constant
0.031***
(0.000)
0.473***
(0.000)
0.109***
(0.000)
0.077***
(0.000)
-0.882***
(0.000)
0.291
(0.231)
-0.269
(0.212)
0.239***
(0.000)
4.765***
(0.000)
-0.229***
(0.002)
0.453***
(0.006)
-7.099***
(0.000)
-4.652***
(0.003)
10.629***
(0.000)
0.001
(0.956)
-0.137
(0.658)
-0.027
(0.267)
0.094**
(0.012)
-0.562
(0.182)
-0.922
(0.319)
7.523***
(0.000)
State-owned Banks
Private Politically Connected Banks
(PBCON)
PBCON*FOB
Diversification
Lerner Index
Equity to Total Assets
Net Interest Margins
Listed Banks
Foreign Banks (FOB)
Constant
ROA
1.724***
(0.000)
ROE
17.605***
(0.000)
INTDEP
-2.658***
(0.000)
0.955***
(0.000)
-1.314***
(0.002)
0.028***
(0.000)
0.404***
(0.001)
0.122***
(0.000)
0.039
(0.120)
-0.623***
(0.000)
0.792***
(0,001)
-0.392*
(0.069)
7.720***
(0.000)
-9.568***
(0.000)
0.199***
(0.000)
3.942***
(0.000)
-0.098
(0.297)
0.018
(0.923)
-3.753***
(0.000)
-0.062
(0,973)
9.665***
(0.000)
-1.205***
(0.000)
-0.531
(0.461)
0.004
(0.866)
-0.047
(0.864)
-0.038
(0.136)
0.144***
(0.000)
-1.066**
(0.016)
-1.107
(0.277)
7.479***
(0.000)
Political Connections and Market Power:
Evidence from Indonesia
 The impact of political connections on market
power
 Market power is the ability of a firm to influence
the price of products which can be measured
using Lerner Index
 Political connections might provide “privileges”
for firms, preventing them from competition and
creating industry barrier to entry
Lerner Index (Market Power)
Political Connections
CAR
LNTA
FOB
LISTED
Model 1
Model 2
0.305***
0.133
(0.086)
(0.252)
0.002
0.002
(0.002)
(0.002)
0.054***
0.052***
(0.007)
(0.015)
0.203***
0.207***
(0.036)
(0.072)
-0.211**
-0.202***
(0.09)
(0.06)
HHI
-0.005
(0.024)
POLCON_HHI
0.02
(0.029)
Constant
Included
Included
Concluding remarks
 Politics remarkably influences finance and banking at the
micro level particularly in countries with high level of
corruption, weak legal systems and poor governance
(Faccio, 2006)
 Politically connected firms may be benefitted of their
connections in the short term (improve performance,
higher probability of being bailed out, access to funding
with a lower cost …..)
 However, it may harm the society as a whole. It could also
be a detrimental factor for well-distributed economic
growth.
Future Research Agenda
 How do politicians extract resources from
IPOs of government-controlled firms?
 Political cycle and lending of state-owned
banks: The power of incumbency
 Do state-owned banks prefer to channel loans
to politically connected firms?
 …………………………………
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