Political Connection and Stock Returns: A Longitudinal Study

• DOI: http://doi.org/10.1111/fire.12061
• Date: 01 February 2015
• Published date: 01 February 2015
• Author: Sireethorn Civilize,Udomsak Wongchoti,Martin Young

The Financial Review 50 (2015) 89–119

Political Connection and Stock Returns:

A Longitudinal Study

Sireethorn Civilize

The Securities and Exchange Commission of Thailand†

Udomsak Wongchoti∗

Massey University, New Zealand

Martin Young

Massey University, New Zealand

Abstract

A stock market should display informational efficiency and, therefore, should appropri-

ately reflect the value of political connections, if any value exists. Using a comprehensivedata

set that incorporates both obvious and less obvious political connections to firms in Thailand,

we provide a longitudinal study which shows that higher realized stock returns are systemati-

cally associated with political connectedness. Consistent with the view that such a relationship

provides economic rents, this finding is particularly prominent in more regulated industries.

The politically connected premium is higher for higher level political connections and when

the political bodies hold an equity stake in the firm.

Keywords: political connections, stock returns

JEL Classifications: G14, G34

∗Corresponding author: Udomsak (Jeff) Wongchoti,School of Economics and Finance, Massey Univer-

sity,Palmerston North, New Zealand; Phone: (646) 350 5799 #84053; E-mail: J.Wongchoti@massey.ac.nz.

We acknowledgeresearch supports from Suresh Oad Rajput.

†The Securities and Exchange Commission disclaimsresponsibility for any private publication or statement

by any of its employees. This paper expresses the authors’ views and does not necessarily reflect those of

the Commission, the Commissioners or other members of the staff.

C2015 The Eastern Finance Association 89

90 S. Civilize et al./The Financial Review 50 (2015) 89–119

1. Introduction

A positive relation between political connections, economic rents, and firmvalue

is observable globally.1This being the case, we arguethat if political connections are

an important determinant of firm value, their existence, intensity, and characteristics

across firms should be systematically reflected in stock returns. Empirical evidence

to support this view is lacking in the finance literature. We test whether the impact of

political connections on firm value is evident in stock returns in Thailand. We further

examine whether the type of political ties, political bodies’ stakes, and industry group

play an important role in the magnitude of these relationships.

The research questions set forth above are difficultto address for several reasons.

First, a researcher needs to be thorough in identifying the political connections of

a corporation, both those that are obvious and those that are less obvious, in a way

that an active stock market investor would do when trading. Second, a long study

period is essential to avoid data snooping bias and to ensure that the findings hold

in the long run. Ready-to-use databases that address these two points are scarce, if

available at all. Third, to increase the frequency of political shifts in the sample, such

a study would ideally be carried out over a long-horizon period in an environment

where political powers often shift. Existing empirical evidence on the impact of

political connections on stock returns tends to focus on event studies surrounding key

political figures, or only covers short periods of time. For example, Fisman (2001)

reports stronger cumulative abnormal returns among companies related to former

President Suharto surrounding news about his health. Such study is conducted on the

Indonesian stock market during the 1995–1997 period and makes use of the readily

compiled “The Suharto Dependency Index.” Johnson and Mitton (2003) examine the

effect of a capital control policy on the stock returns of companies in Malaysia that

were strongly affiliated with Prime Minister (PM) Mahathir and Deputy PM Anwar

during the 1997–1998 Asian financial crisis.

To help counter these issues, we examine the stock market of Thailand (Stock

Exchange of Thailand [SET]), as it provides a useful and unique empirical setting.

As a primer, Thai firms are renowned for being strongly associated with cronyism

and constant economic rent seeking through political connections. These activities

are shown in the literature to create value, as will be discussed in a later section of this

paper. Furthermore, political powerchanges happen relatively frequently in Thailand.

In fact, none of the elected governments, except one, has completed a full four-year

term in its history.This implies that both Thai firms and their investors need to actively

keep updated with these value-related changes and consider them in their business

decisions. Detecting the political connections of a Thai firm represents an interesting

“catch me if you can” scenario. While Thai politicians haveto conceal their affiliations

1See, for example, Talmud (1992), Kroszner and Stratmann (1998), Sapienza (2004), Khwaja and Mian

(2005), and Goldman, Rocholl and So (2009), among others.