Political Connection as an Investor Endorsement Device (CEIBS Working Paper, No. 008/2020/FIN)

Due to its value to private firms, a firm’s political connection (PC) enhances the alignment of external investors with insiders, thereby mitigating the adverse impact of market frictions on corporate financing and investment. This has important implications on corporate policies and governance. Using various identification strategies, we show that PC firms are more likely to issue equity and invest more, while paying out less in dividends. The market responds more positively to news of equity issuance and investment, but less so to news of dividend payouts by PC firms. Moreover, external investors vote more favorably on managerial proposals in PC firms’ annual meetings. And analysts are more optimistic in their forecasts of earnings by PC firms. The evidence is consistent with PC as an investor endorsement device, which in turn incentivizes unconnected firms to proactively seek PC.