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Do Strong Corporate Governance Firms Still Require Political Connection? Chung- Hua Shen Yu-Chun Wang Chih -Yung Lin

2012 NTU Conference . Do Strong Corporate Governance Firms Still Require Political Connection? Chung- Hua Shen Yu-Chun Wang Chih -Yung Lin . 2012.12.7. Outline:. 1. Introduction 2. The Data 3. Empirical Results 4. Conclusions . 1. Introduction. Main Question.

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Do Strong Corporate Governance Firms Still Require Political Connection? Chung- Hua Shen Yu-Chun Wang Chih -Yung Lin

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  1. 2012 NTU Conference Do Strong Corporate Governance Firms Still Require PoliticalConnection? Chung-HuaShen Yu-Chun Wang Chih-Yung Lin 2012.12.7

  2. Outline: • 1.Introduction • 2. The Data • 3. Empirical Results • 4. Conclusions

  3. 1.Introduction

  4. Main Question • whether a firm with strong CG still requires PC? • Are CG and PC Substitutionor complementary? • We also test whether CG or PC itself is enough for a firm to obtain better termsof bank loan contracts?

  5. Literature • 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

  6. Previous Literature: CG v.s. Cost of debt • Negativecorrelation: • 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.

  7. Previous Literature: PC v.s. Cost of debt Negativecorrelation: • 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.

  8. Substitution Concepts • 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.

  9. Complementary Concepts • CG and PC may be complementary. • Although engaging in both CG and PC is costly, BUT it also increase the chance of the business.

  10. Three Hypotheses:H1a • 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.

  11. Three Hypotheses:H1b • 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.

  12. Three Hypotheses:H2 • 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.

  13. Three Hypotheses:H3 • 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.

  14. <Our contributions> • 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.

  15. <Our contributions> • 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.

  16. 2.The data

  17. 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

  18. Data • 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.

  19. Data • 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.

  20. 3.Empirical Results

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

  22. Hypothesis 1a: Better-governed firms could obtain better treatments in bank loan prices. 23

  23. Hypothesis 1a:Better-governed firms could obtain better treatments in bank loan prices. 24

  24. Hypothesis 1b: Firms with stronger PCs could similarly obtain better treatments in bank loan prices. 25

  25. Hypothesis 1b: Firms with stronger PCs could similarly obtain better treatments in bank loan prices.Table 5. Political connections and bank loan price 26

  26. 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 corporategovernance types 27

  27. 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 28

  28. Hypothesis 2:The substitution view suggests PC firms have poorer governance, The complementary view suggests that they have better governance. 29

  29. 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 30

  30. Hypothesis 3: • The substitution view suggests that compared with considering only one concept, considering both PC and CGwould 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

  31. Hypothesis 3: 32

  32. Hypothesis 3: The substitution view :strong CG + strong PC >>>favorable terms decrease The complementary view: >>>favorable terms increaseTable 9. Corporate governance vs. political connection: Bank loan price 33

  33. 4.Conclusion

  34. 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

  35. 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

  36. Thank you !Comments are welcome.

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