Firms with strong political connections are more likely to get preferential access to capital, especially in emerging markets and corrupt countries (Johnson and Mitton 2003; Khwaja and Mian 2005; Charumilind et al. 2004; Claessens et al. 2008). Nevertheless, Chaney et al. (2010) find that politically connected firms have lower accounting quality. Low accounting quality can result in a number of negative consequences, including a higher cost of capital (Francis et al. 2005).
Which begs the question: what is the mechanism by which political connections facilitate a firm’s effort to raise capital? Is it because managers’ political connections are one dimension of management quality that influences the judgments of regulators, ratings analysts, and market participants? Is it possible that political pressure and intervention on behalf of connected parties substitute for better quality disclosures? To date there is little empirical evidence to substantiate either of these arguments, likely because of the lack of data regarding managers’ political connections. To explore this question, this paper uses a unique, manually constructed database to study whether and how the political connections of issuing firms influence offering amounts and issuer credit ratings in the bond issuance process. This paper also explores the effects of the political connections of bank underwriters on bond capital access.
At least three mechanisms are possible when explaining the positive relationship between political connections and a firm’s ability to raise capital. First, the relationship may be explained using a reputation enhancement argument which suggests that the political connections of firm executives serve as an alternative channel for establishing firm reputation when quality disclosure is absent. This helps firms gain easier access to debt capital.
Second, this relationship could be explained through a social lending argument; that is, the bond issuance process is guided by the government’s efforts to improve social welfare, and the government assigns bureaucrats to firm executive teams in order to better monitor firms’ use of financial resources that are granted to perform these socially beneficial projects. Finally, a collusion argument could explain the relation. Firms use their connections to engage in activities that will influence the government’s bond issuance approval decisions, and the government shows partiality to firms whose executives promise to return politicians’ personal favors. In other words, the bond issuance process is influenced by the desire of individual politicians to seek rents.
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Political Connections and Access to Bond Capital: Reputation or Collusion?
