Do Strong Corporate Governance Firms Still Require Political

Connection?

Chung-Hua ShenYu-Chun Wang Chih-Yung Lin

2012.12.7

2012 NTU Conference

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1. Introduction

2. The Data

3. Empirical Results

4. Conclusions

Outline:

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1. Introduction

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whether a firm with strong CG still requires PC?

Are CG and PC Substitution or complementary?

We also test whether CG or PC itself is enough for a firm to obtain better terms of bank loan contracts?

Main Question

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Previous studies commonly studied these two concepts separately.

However, their joint influence have been rarely discussed:

Chaney et al. (2011) demonstrated that among firms, those with PC reported lower quality of financial statements.

Wahab et al. (2011) argue that PC does not alter the positive relationship between CG and audit fees

Literature

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Negative correlation: Bhojaraj and Sengupta (2003) stated that lower

bond yields and higher credit ratings are associated with higher institutional ownership and a larger fraction of the board composed of non-officers.

Anderson et al. (2004): concluded that the cost of debt is inversely related to board independence and fully independent audit committees.

Lin et al. (2011) noted that the cost of borrowing is lower in firms with a narrower divergence between their control and cash flow rights.

Previous Literature: CG v.s. Cost of debt

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Negative correlation:

Sapienza (2004) determined that government-owned banks charge lower interest rates in regions where the bank-affiliated party obtained a higher voting rate.

Khwaja and Mian (2005) also examined the political influence on preferential treatment using data from Pakistan.

Claessens et al. (2008) discovered that contributing firms substantially increase their loan growth in comparison with non-contributing firms after each election.

Previous Literature: PC v.s. Cost of debt

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A firm with strong CG may obtain favorable loan contracts with their positive reputation, and needs no connections with the government.

PC is also valuable for firms, as politicians tend to give their supporters favors (Shleifer and Vishny, 1994).

However, both CG and PC is costly; hence, a firm can either develop its CG or build its PC.

Substitution Concepts

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CG and PC may be complementary.

Although engaging in both CG and PC is costly, BUT it also increase the chance of the business.

Complementary Concepts

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Corporate governance can alleviate agency problems and improve corporate disclosures.

Ex: Anderson et al. (2004): concluded that the cost of debt is inversely

related to board independence and fully independent audit committees.

Lin et al. (2011) noted that the cost of borrowing is lower in firms with a narrower divergence between their control and cash flow rights.

Hypothesis 1a: Better-governed firms could obtain better

treatments in bank loan prices.

Three Hypotheses: H1a

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Most literature report that politically connected firms are more likely to obtain favored access to debt financing relative to non-connected firms.

Ex: Sapienza (2004) determined that government-owned banks charge lower

interest rates in regions where the bank-affiliated party obtained a higher voting rate.

Khwaja and Mian (2005) also examined the political influence on preferential treatment using data from Pakistan.

Hypothesis 1b: Firms with stronger PCs could similarly

obtain better treatments in bank loan prices.

Three Hypotheses: H1b

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We examine the correlation between CG and PC.

Ex: Chaney et al. (2011) stated that among politically connected

firms, those with stronger political ties have the poorest accruals quality.

Hypothesis 2: The substitution view suggests politically

connected firms have poorer governance, whereas the complementary view suggests that they have better governance.

Three Hypotheses: H2

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We analyze whether CG and PC are substitutes or complements in determining bank loan contracting.

Hypothesis 3: The substitution view suggests that

compared with considering only one concept, considering both PC and CG would not significantly reduce bank loan prices.

The complementary view suggests that considering not only one but both concepts increases the loan term benefits.

Three Hypotheses: H3

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We add to the increasing literature on CG and PC, given that earlier studies focus only on the individual concepts.

Our discussion focuses more on the interaction of CG and PC when banks provide benefits in making loans.

This study also relates to the perception of bankers on the “contributions” of CG or PC when processing loans.

<Our contributions>

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Our results have strong policy implications.

In a country where CG is stressed, the influence of PC on the loan contract

may be insignificant.

Accordingly, governments could minimize political influence by stressing CG.

<Our contributions>

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2. The data

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Data 1. Data Sources of Bank Loan

Contracts TEJ bank loan database

Final sample that contains 8,774 firm-year observations with 758 individual firms involved in 71,069 bank loan contracts.

2. CG variables are also collected from the TEJ database

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Political connections Measures Hand-collected from various media, websites,

and other sources.

The background of all top managers in each listed firm was traced to identify their connections with the government.

Data

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Our PC involves two measures. 1. political party tendency: Ex: top managers who served as central

committee members of the two political parties 2. political appointment: Ex: top managers were either appointed as

government officials or served as CEOs, general managers, or board directors in government-owned enterprises from 1997 to 2009.

The numbers of PC and Non-PC firms are 131 (17.28%) and 627 (82.72%) respectively.

Data

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3. Empirical Results

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In Panel C, politically connected firms account for 30% of the bank loan sample.

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Hypothesis 1a: Better-governed firms could obtain better

treatments in bank loan prices.

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Hypothesis 1a: Better-governed firms could obtain better treatments in bank loan prices.

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Hypothesis 1b: Firms with stronger PCs could similarly obtain

better treatments in bank loan prices.

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Hypothesis 1b: Firms with stronger PCs could similarly obtain better treatments in bank loan prices.

Table 5. Political connections and bank loan price

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Hypothesis 2: The substitution view suggests PC firms have poorer governance,

The complementary view suggests that they have better governance.

Table 6. Descriptive statistics: PC firms in different corporate governance types

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Hypothesis 2: The substitution view suggests PC firms have poorer governance,

The complementary view suggests that they have better governance.

Table 7. Differences in descriptive statistics: PC and non-PC firms

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Hypothesis 2:

The substitution view suggests PC firms have poorer governance, The complementary view suggests that they have better governance.

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Hypothesis 2: The substitution view suggests PC firms have poorer governance,

The complementary view suggests that they have better governance.

Table 8. Corporate governance in politically connected firms

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The substitution view suggests that compared with considering only one concept, considering both PC and CG would not significantly reduce bank loan prices.

strong CG + strong PC >>> favorable terms decrease The complementary view suggests that

considering not only one but both concepts increases the loan term benefits.

strong CG + strong PC >>> favorable terms increase

Hypothesis 3:

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Hypothesis 3:

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Hypothesis 3: The substitution view : strong CG + strong PC >>> favorable terms decrease The complementary view: >>> favorable terms increase

Table 9. Corporate governance vs. political connection: Bank loan price

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4. Conclusion

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We address the following questions:

Do firms with strong CG still require PCs?

Are CG and PC substitution or complement?

we also discuss whether better-governed or politically connected firms acquire benefits in bank loan contracts.

Conclusion

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1. strong CG >>favorable loan rates strong PC >> favorable loan rates

2. PC firms tend to have poor CG.

3. strong CG + strong PC >>> favorable terms decrease [supporting the substitution effect]

4. this result may also explain why firms with strong CG do not require PC.

Conclusion

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Thank you !Comments are welcome.