Finance and Politics: The Invisible Lending Hand

by Janice How

Was the sacking of Prime Minister Kevin Rudd, a manifestation of the cosy relationship between government and the Australian financial sector? QUT’s Professor of Finance, Janice How, believes that relationships like this can only impede the development of financial systems.

It is no secret that the worlds of corporations and politics often intersect – money and power have always been natural partners. One well documented case of the close business-government relationship, more fomally described as cronyism, is exemplified by firms connected to the late former Indonesian President Suharto and his family. These connected firms were reported to have derived a significant percentage of their value from the said connections (Fisman, 2001). Politically connected firms have also been known to enjoy other benefits, including lighter taxation; preferential treatment in competition for government contracts and debt funding; relaxed regulatory oversight or stiffer regulatory oversight of rival non-connected firms; and government bailouts. Indeed, the rapid economic growth in the East Asian region in the 1980s and 1990s has been attributed to the close business-government connections (Jomo, 2001).

Controversial as it is, we cannot however ignore the adverse effects that resource misallocation caused by cronyism can have on the capital market and individual firms. In Mexico, for example, well-connected banks were found to have engaged in a considerable amount of irresponsible lending before the 1995 crisis (La Porta, Lopez-de-Silanes and Zamarippa, 2001). Similarly, both the IMF and many academics believe that without uprooting the institutional structure of crony capitalism that underpinned the 1997 Asian financial crisis, the prospects for the region are dim (Khan and Jomo, 2001).

Australia has its own share of political leaders with business connections, as witnessed in the recent removal of Labor Prime Minister Kevin Rudd. Rudd’s dispatchers (the so-called Labor “heavies”), who allegedly have direct connection to big business, were reported to have taken action on behalf of the mining and other corporate executives, and their opposition to Rudd’s proposed 40 percent resource super-profits tax (http://www.wsws.org/articles/2010/jul2010/rcou-j10.shtml). With the federal election now behind us and the Labor party holding office with the slimmest of margins, it seems timely and relevant to ask at this point what exactly the role of politics is in Finance.

A group of researchers, consisting of staff members and postgraduate students at QUT, have been investigating this question to see whether political connections are related to firm performance and transparency. Their research shows that firms with political connections tend to have lower quality corporate governance, consistent with the 2002 McKinsey Emerging Market Policymaker Opinion Survey on Corporate Governance which reports that politicians are one of the major obstacles to corporate governance reforms. Because political connections are thought to decrease financial transparency, with reported earnings of politically connected firms less accurately capturing underlying economic events, QUT researchers also examine how these connections impact on the information processing ability of one important user group of financial information – professional financial analysts. Their results show that analysts are significantly less able to accurately forecast the earnings of politically connected firms than other firms, consistent with the greater opacity in the information environment of politically connected firms.

In conclusion, although politicians can facilitate economic growth, as has been the case in the East Asian region, the potential collusive behaviour between politicians and firms can also retard the development of the financial system. The very lack of transparency of connected firms, as noted by QUT researchers, will not only increase their cost of capital but it will also make it more difficult to detect abuses in a system where politicians lend a hand  to selected groups of firms.

Janice How is Professor of Finance at Queensland University of Technology.

References

  • Fisman, R., 2001, Estimating the Value of Political Connections, American Economic Review 91: 1095-1102.
  • Jomo, K.S., 2001, Malaysian Eclipse: Economic Crisis and Recovery, Zed Books, New York.
  • Khan, M. and K. Jomo, 2001, Rents, Rent-Seeking and Economic Development: Theory and Asian Evidence, Cambridge: Cambridge University Press.
  • La Porta, R., F. Lopez-de-Silanes and G. Zamarippa, 2001, Related Lending, manuscript, Harvard University, April 3.

 

We welcome your input. Comments are submitted for possible publication on the condition that they may be edited. Please provide your name or pseudonym. We also require a working email address – not for publication, but for verification.

Tags: , , , , , , , , , , , , , , ,

One Response to “Finance and Politics: The Invisible Lending Hand”

  1. Jeremy Webb Says:

    Your comments on the effect of political connections on corporate governance are but part of the story. The laws relating to financial contributions to political parties in Australia are some of if not the laxest in the western world. In other words there is a very wide scope for corporates (or trade unions) to buy political influence and often avoid scrutiny.

    It would be difficult to argue that companies should not lobby politicians. However what finanical donations buy is access to politicians so that they can be directly lobbied. That raises the rather nasty questsion of whether this amounts to bribery. For some strange reason we deem it to be legal in these cases but prosecute others for similar activity outside of politics.


Privacy | Copyright matters | Accessibility
Contact us | Feedback | Disclaimer
Opinions expressed in this blog are those of the individual contributors only.
QUT Home | Blog Home