Political Connections and Firms´ Performance in CEEC

Political connections and their impact on firm`s valuations, and costs of financing have recently received increasing attention in the finance literature. Several studies document connections between firms and politicians, using firm- level data. Most of the studies analyze a single country and use different definitions of political connections, which makes cross-country comparison virtually impossible. There is no cross-country study on politically connected companies in Central and Eastern European countries. The aim of this project is to fill this gap by exploring the effects of political connections, their distribution across countries and interplay with country and firm characteristics. Our interest in CEE countries is motivated by the specific legal and economic environment in which they operate. These countries underwent a transition process from planned to market economy. This resulted in significant changes in ownership and control structures. Since market institutions in most of the countries were underdeveloped, secondary market trading of the shares of privatized companies often resulted in ownership concentration in the hands of a few politically connected owners. The goal of this project is to answer four main questions. First, we are interested to empirically investigate the phenomenon of politically connected firms in CEEC. In particular we wish to identify politically connected firms and their cross country distribution. Our second goal is to determine the effect of political connections in CEEC on firms` performance. We hypothesize that these ties improve firm performance and are used as substitute for the weak institutional environment. Further, we wish to study how these connections affect the value of the firm and its capital structure. Finally, the current financial crisis allows us to study, whether differences in firms` performance during the crisis are due to differences in the status of political connections. As a basis for our research we will use a data set that we have created. It is a panel of firm years of companies in 11 Central and Eastern European countries (Russia, Slovenia, Slovakia, Romania, Bulgaria, Croatia, Czech Republic, Lithuania, Latvia, Estonia and Poland), during the period 2000 to 2007. We have built a unique data set of 1878 firm year observations which provides information on the type of ultimate owner of every company in the sample. In order to accomplish the goals of this project we intend to enrich this data set and hand collect detailed data about political connections of every single firm.

The effect of political connections on firm performance, valuation and cost of funding has recently received increasing attention in the academic finance literature. Several studies document connections between firms and politicians, using firm-level data and seem to conclude that such connections significantly influence corporate performance. Most of the existing studies analyze a single country and use different definitions of political connections, which makes cross-country comparison virtually impossible. Also, the specific channels through which such effects may be created are not yet well understood. Central and Eastern European countries provide an ideal setting to explore these issues. First, there was a quasi-natural experiment around the time when the Soviet Union collapsed and new political and economic governance structures were established in the early 90s. Second, despite similar initial conditions, there is substantial cross-country variation in the governance structures the various CEEC countries established. This creates the opportunity to shed more light on the interplay between political connections and firm performance. The aim of this project is to explore the effects of political connections, their distribution across CEEC countries and their interactions with country and firm characteristics. As a basis for our research we use a data set that we have created. It consists of a panel for the period from 2000 to 2011 for 11 Central and Eastern European countries: Russia, Slovenia, Slovakia, Romania, Bulgaria, Croatia, Czech Republic, Lithuania, Latvia, Estonia and Poland. For each of firm year we have information about the type of ultimate owner of every company, the political connections, and other information such as balance sheet data and stock market capitalization. In addition we have country-wide data, such as measures of political stability, control of corruption or the rule of law. Our empirical results indicate that larger, less risky firms are more likely to be politically connected. Also, firms in industries such as Telecommunications or Gas, Coal Extraction Products are much more likely to exhibit political connections than industries such as Manufacturing or Consumer Non-Durables. Furthermore, we show that firms in countries with lower quality institutional environments are more likely to establish political connections. Overall we find that political connections unambiguously improve firm performance, as measured by Tobin's q or return on assets. We find that politically connected firms controlled by a large individual shareholder exhibit the best performance. It will be interesting to explore in future research whether the positive relation between political connections and firm performance is due to efficiency gains or due to rent extraction.