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Political institutions, connectedness, and corporate risk-taking

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Abstract

We investigate the impact of political institutions on corporate risk-taking. Using a large sample of non-financial firms from 77 countries covering the period from 1988 to 2008, we find that sound political institutions are positively associated with corporate risk-taking, and that this relation is stronger when government extraction is higher. In a subsample of 45 countries, we also find that politically connected firms engage in more risk-taking, which suggests that close ties to the government lead to less conservative investment choices. Our results are economically significant, and are robust to alternative risk-taking measures, various political institution proxies, cross-sectional and country-level regressions, and endogeneity concerns of political institutions. Our results have important implications for governments and corporate managers by providing direct relevance of political institutions to the corporate decision-making process. To encourage investment at the firm level, and hence innovation and overall growth, governments need to undertake the necessary reforms to control corruption and enforce contracts better, and thus decrease government predation and extraction.

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Notes

  1. Greater political constraints on policymakers reflect stronger political institutions (Henisz, 2000).

  2. Labor unions are found, for instance, to be less influential under less constrained governments (e.g., Pagano & Volpin, 2005; Roe, 2003). Therefore risk-taking by managers is more likely to be higher under more authoritarian governments.

  3. Alternatively, since managers of politically connected firms are not as closely monitored by shareholders as those of their non-connected peers, they are likely to be more entrenched and more powerful, owing to their connections. Consequently, managers of connected firms may have lower incentives to engage in risky projects.

  4. All 39 countries covered in the John et al. (2008) study are included in our sample.

  5. Henisz’ (2010) dataset used to estimate the political constraint index is an updated version of his earlier work (i.e., Henisz, 2000).

  6. See, for example, Stulz (2005) and Qi et al. (2010) for the use of the political constraints index.

  7. The Gastil indices measure the degree of democracy in a given country, but are not necessarily correlated with the degree of commitment to private property rights, and the widely used political instability measures are not suitable when one considers autocratic regimes.

  8. For a detailed description of the political connections database, see Faccio (2006). Examples of political connections from developed economies include firms connected to the Italian prime minister, Silvio Berlusconi. Connections in Malaysia and Indonesia relate mainly to the prime minister Mohamad Mahathir and President Suharto, respectively.

  9. Our results remain qualitatively similar when we include outliers. Indeed, in the primary specification of Table 3, POLITICAL loads positive (= 0.042) and is statistically significant at the 1% level (t-stat = 4.52).

  10. The last year of entrance of the independent variables is 2004 for RISK1 calculated over 2004–2008.

  11. Note that in some specifications in John et al. (2008) there is a negative but insignificant relation between LAWORDER and corporate risk-taking.

  12. We exclude the country fixed effect from the regressions, given that CNT_FRAC does not vary across time for any given country. See also Faccio et al. (2011) for a similar approach.

  13. Hofstede's individualism–collectivism index is widely used in the international business literature (e.g., Brewer & Venaik, 2011; Lim, Leung, Sia, & Lee, 2004; Morris, Davis, & Allen, 1994).

  14. Our results are qualitatively similar when we exclude countries without a connection.

  15. We perform the Stock and Yogo weak identification test and the Kleibergen and Paap under-identification test, and find that CAPITAL is an appropriate instrument.

  16. Chaney et al. (2011) analyze the quality of accounting information in politically connected firms, and calculate the standard deviation of residuals during 1996–2005.

  17. We also consider different country subsamples. Excluding the largest number of politically connected firms in the United Kingdom and politically connected firms from East Asian countries (Thailand, Indonesia, and Malaysia) in separate regressions, we find similar results.

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Acknowledgements

We thank Najah Attig, John Cantwell (Chief Editor), Sadok El Ghoul, Omrane Guedhami, Jeffrey Pittman, Samir Trabelsi, and especially David Reeb (Area Editor) for their insightful comments and suggestions, which greatly improved the paper. We appreciate financial support from Canada's Social Sciences and Humanities Research Council, as well as excellent research assistance from Heba Abu Ghazalah, and Mira Mneimneh. All remaining errors are ours.

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Authors and Affiliations

  1. School of Business and Management, American University of Sharjah, Sharjah, United Arab Emirates

    Narjess Boubakri

  2. Pampline College of Business, Virginia Tech, Blacksburg, USA

    Sattar A Mansi

  3. School of Accounting and Finance, The Hong Kong Polytechnic University, Hong Kong, China

    Walid Saffar

Authors
  1. Narjess Boubakri
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  2. Sattar A Mansi
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  3. Walid Saffar
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Correspondence to Narjess Boubakri.

Additional information

Accepted by David Reeb, Area Editor, 6 January 2013. This paper has been with the authors for four revisions.

Appendix

Appendix

Table A1

Table A1 Variable definitions
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Boubakri, N., Mansi, S. & Saffar, W. Political institutions, connectedness, and corporate risk-taking. J Int Bus Stud 44, 195–215 (2013). https://doi.org/10.1057/jibs.2013.2

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