Corporate Political Donations and Rent-Seeking Activities - Coursework Example

Name: Tutor: Title: Corporate Political Donations and Rent-Seeking Activities Course: Date Corporate Political Donations Introduction Nowadays, corporate political donations are prevalent throughout the world. Previous research indicate that political ties influence corporate value. Political donations are important for corporations as well as politicians as they help both to achieve their objectives. Crucial to the concept of political donations is a regular exchanges of favors between corporation and politicians (Faccio, 2010). Corporate political donations can contribute to the conflicts of interests between controlling shareholders and minority shareholders. They can be a kind of perquisite consumptions by controlling shareholders, imposing costs outside minority stakeholders (Aggarwal, Meschke and Wang, 2009). This paper will explore this mechanism so as to gain a deeper understanding of the issues involved and ascertain whether political donations add value to the corporations. It will also provide empirical evidence to show that there is significant correlation between corporate political donations and rent-seeking activities by Australian listed companies. Corporate political donations can take various forms across firms and therefore it is difficult to come up precise definition of the phrase. The major reason why companies establish relations with politicians is to affect the political process in a manner which may improve company performance. Politicians can influence government expenditure in a manner which is favorable to the firms that give them donations. Personal relationships between companies and politicians tend to create long-term relationships until the politician is removed from power or dies (Cooper, Gulen and Ovtchinikov, 2010). Companies view political donations like investing in political capital. When companies contribute money to politicians they have frequent access to them and obtain better quality. Various research studies have demonstrated that political contributions are significantly correlated with organizational performance and value (Cooper, Gulen and Ovtchinikov, 2010 and Claessens, Feijen and Laeven, 2008). At the same time, political donations should be viewed basically as a kind of consumption good because companies obtain comparatively little power from their donations. Moreover, corporate political donations cannot be viewed as an investment because they tend to establish temporary and transactional relationships with politicians (Aggarwal, Meschke and Wang, 2009). Therefore, political contributions may not have the same effect as political connections created using personal ties. There are several economic benefits which firms can obtain from contributing to politicians (Johnson and Mitton, 2003; Faccio, Masulis and McConnell, 2006). Firms can be assured that the politician will come in handy in times of need. Politicians may use their power to grant favors to firms that have given them contributions. These political favors can come up in various forms such as favored access to credit, lighter taxation, government contracts, capital control, regulatory protection and government benefit for financially troubled companies (Johnson and Milton, 2003; Faccio, 2010; Goldman, Rocholl and So, 2013). According to resource-based theory, a company can gain competitive advantage if it has tangible and intangible resources which other companies find it difficult or costly to obtain. Hence, corporate political donations are viewed as potential resources which increase the value of the company. Preferential lending is considered as the greatest benefit of corporate political donations. Political contributions provides companies access to resources such as bank financing. To be able to finance future investment opportunities companies should be able to obtain capital. Therefore, it is critical to contribute to politicians who can provide the company with favored access to credit from financial institutions controlled by government that may charge a lower rate of interest than the current market rate (Khwaja and Mian, 2005). The other way political donations can lead to favored access to fund is through state banks (Claessens, Feijen and Laeven, 2008). Private lenders tend to facilitate lending to firms that give contributions to politicians (Faccio, Masulis and McConnell, 2006). Government tend to pressure private banks to give preferential loans firms that give political contributions (Khwaja and Mian, 2005). Research shows that firms which contribute to politicians have 2.7% greater influence than those which do not contribute (Faccio, 2010). This political meddling in bank credit allocation can result to loan decisions which are insensitive to the control and risk of the borrowing contributors firms. Often, banks are under pressure from the government to give loan to contributors firms despite them having an unprofitable forecast (Khwaja and Mian, 2005). This shows that political donations through favorable lending may result in increased company value only if there is a capital transfer from banks to the contributor firm. Contributor companies can increase value when they are capable of extracting financial rent from competitors. Politically connected firms also obtain aids from direct government resources and support, such as lowering taxation, reducing regulatory requirements, imposing of prices on competitors and the awarding of profitable government contracts. Firms which contributes to politicians are advantaged when it comes to exporting, lobbying and selling to government. The government tend to allocate procurement contracts to firms which gave them contributions (Goldman, Rocholl and So, 2013). Literature also shows that politically connected firms receives more subsidies as well as enjoy lower company taxation. Moreover, research demonstrates that politically connected firms experience a lower company tax rate by 0.76% points and hence benefit from reduced operating costs (Faccio, 2010). Generally, corporate political donations provide economic benefits to companies through channeling to them critical support and resources from the government. Furthermore, politically favorable companies are linked to lower risk than non-contributors firms. Political connections are particularly useful when connected firms experience financial distress. During financial crisis time, the government tend to impose capital control measures in favor of the politically connected companies. The government comes up with capital control policies which pressure banks to facilitate loaning to preferential companies. In short, the government comes up with capital control measures so as to assist connected companies (Johnson and Mitton, 2003). Private creditors tend to expedite loaning to connected companies because they expect that government are more probably to bond out connected firms in financial crisis or economic depression (Faccio, Masulis and McConnell, 2006). Political connections serves to guarantee that the money lend will be returned and hence, this lowers the overall exposure of the connected firm to general market risk. This reduces the difference between the market and the cash flows of the connected firm, generating a reduced cost of assets for the connected company. Despite the fact the level of revenues reported by connected companies is considerably lowers compared to that of non-connected firms, the former is not penalized by the market because their rate of debt is worse than that of the latter (Chaney, Faccio and Parsley, 2011). Politically connected companies have reported a lower rate of equity capital than non-connected counterparts. This shows that investors requires a lower cost of capital for connected firms, meaning that connected companies are viewed as less risky compared to non-connected companies (Boukari, Guedhami, Mishra and Saffar, 2012). On the other hand, political connections may inflict expenses on the connected companies. For instance, the incumbent politicians may use authority to influence directors to make company decisions which grant favor affecting re-election results for themselves. As a result, connected firms may be forced to devote huge resources to rent-seeking activities of politicians that in turn might distort their own share decisions and company value. Studies show that the major reason for government intervention is rent-seeking activities. Politically connected firms reports lower industry-adjusted operational performance, R&D costs and labor capital ratios compared to non-connected firms. Moreover, they tend to report lower rates of returns on assets (ROA) and stock performance than non-connected companies, particularly during election times. This lower profitability can be attributed to the connected companies need to create more employment opportunities so as to gain extra backup votes for the concerned politician (Boubakri, Guedhami, Mishra and Saffar, 2012). Political donations are most evident in large companies because politicians can gain the most from giving favors to them (Johnson and Mitton, 2003; Cooper, Gulen and Ovtchinnikov, 2010; Boubakri, Guedhami, Mishra and Saffar, 2012). Subsequently, the cost of corporate political donations is when the linked politicians withdraw political or private favors from other shareholders in the companies. However, rent-seeking activities alone cannot be solely attributed to the low performance of connected companies (Faccio, 2010). Corporate governance can exemplify the expense of political contributions as politically connected firms fail to care about governance that is critical for outside capital raising because of their advantaged access to credits from banks managed by government (Classessen, Feijen and Laeven, 2008). The decreased dependence on external funding implies avoiding essential external monitoring by the market. The value of accounting data of politically connected companies is poor compared to that of non-connected firms because of benefits of having political connections in the loan market. This shows that political intervention may weaken managerial practices resulting in worse corporate governance. Politicians are unlikely to connect with companies with good corporate governance like smaller boards and greater ownership by insiders, financial institutions, separation of CEO and chairman and block holders. This shows that political donations represent a suggestive agency problem (Aggarwal, Meschke and Wang, 2009). Conclusion Corporate political donations is a two-edged sword that may either improve or jeopardize the performance and value of a firm. On one edge, political donations can create potential resources which may enhance the performance and value of the connected company. Economics benefits that companies gain from political donations include government supports and resources, preferential access to credit, low interest rates, and lower cost of debt, profitable government contracts, lighter taxations and imposing tariffs on competitors. On the other edge, political donations can destroy the value and performance of the connected firm. Politicians can engage in rent-seeking activities to achieve their policy goals through taking advantage of the firm’s minority stakeholders. These rent-seeking activities may include forcing the firm to create inefficient employment, misallocate resources and distort investment decisions to their advantage. The difference between marginal aids and marginal expenses of political connections determines the net impact of political donations. References Aggarwal, R. K., Meschke, F., Wang, T., 2009. Corporate political contributions: Investment or agency? Unpublished working paper. University of Minnesota and University of Kansas. Boubakri, N., Guedhami, O., Mishra, D., Saffar, W., 2012. Political connection and the cost of equity capital. Journal of Corporate Finance 18, 541–559. Chaney, P., Faccio, M., Parsley, D., 2011. The quality of accounting information in politically connected firms, Journal of Accounting and Economics, 51, 58–76 Claessens, S., Feijen, E., Laeven, L., 2008. Political connections and preferential access to finance: The role of campaign contributions. Journal of Financial Economics 88, 554– 580. Cooper, M. J., Gulen, H., Ovtchinkov, A. V., 2010. Corporate political contributions and stock returns. Journal of Finance 65, 687–723. Faccio, M., Masulis, R., and McConnell, J., 2006, Political connections and corporate bailouts. Journal of Finance, 61, 2597–2635. Faccio, M., 2010, Differences between politically connected and nonconnected firms: A crosscountry analysis, Financial Management, 39, 905–927. Goldman, E., Rocholl, J., So, J., 2013. Politically connected boards of directors and the allocation of procurement contracts. Review of Finance 17, 1617–1648. Johnson, S., Mitton, T., 2003. Cronyism and capital controls: evidence from Malaysia. Journal of Financial Economics 67, 351–382. Khwaja, A., Mian, A., 2005. Do lenders favor politically connected firms? Rent provision in an emerging financial market. Quarterly Journal of Economics 120, 1371–1411. Read More