Do political connections matter? : empirical evidence from listed firms in Pakistan

The purpose of this thesis is to enhance understanding of the way in which political connections benefit or impair connected firms. For this purpose, the current study employs the data of Pakistani listed non-financial firms from 2002–2010, and examines the impact of political connections on the economic life of individual firms. More specifically, this thesis comprises three empirical studies: the first enquires into the way in which political connectedness influences firms’ access to finance; the second empirical chapter examines the impact of political connections on the performance of the connected firms; and lastly, the third empirical chapter explores the channels through which connected politicians intervene in business operations. The findings in the first empirical chapter provide strong and robust evidence of preferential lending in the credit market. Political connectedness appears to be a determining factor of the total and long-term leverage of the firms; nevertheless, short-term financing is indifferent to political connections. The study also finds that having connections with a winning politician or politician affiliated to the winning parties (coalition) have a larger impact on the firm’s total and long-term leverage, thus implying that the benefits associated with political connections ultimately depend on electoral outcomes. In addition, firm size and business group affiliation have increasing effect on the borrowing capabilities of the connected firms, whilst connections underplay the significance of collateral. Through the use of an instrumental variable framework focused on the long-term panel and cross-sectional data of Pakistani listed firms, the second empirical chapter finds that political connections distort the performance of the connected firms. Consistent results are found for various accounting and marketing measures of performance. So as to investigate the impact of connectedness on performance in different political environments, the sample period is stratified into two contrasting government periods: autocratic; and democratic government periods. The result is more pronounced in the autocratic regime, providing evidence of excessive managerial inefficiencies and rent-extraction of affiliated politicians in dictatorship regime. It was also found that the performance of connected firms increased further if they belonged to business groups, whilst the large firms were subject to severe performance distortions more so than small firms. Finally, those firms with low growth opportunities were more prone to the negative effects of political connectedness in terms of their performances. The findings in the second empirical chapter (connections insert negative effect on the firm performance) inspired us to progress one step further and investigate the intriguing question: what are the channels through which politicians interfere and distort the performance of the connected firms? In quest to answer this question, the last empirical chapter provides strong and robust evidence of political intervention in the investment and employment decisions. More specifically, results find the existence of investment inefficiencies and excessive employment in the connected firms. Importantly, the effect of political interference is more pronounced for employment decisions, indicating the presence of clientelism in the Pakistani market, where politicians distribute job favours in exchange of electoral support. The study also reveals that connected firms with high growth opportunities experience political interference less often than their peers with low growth opportunities. Lastly, the economic cost of such political intervention in employment decisions is estimated to be 0.15% GDP annually.