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Political connections and firm operational efficiencies: evidence from a developing country

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Abstract

This paper investigates the impact of political connections on firm operational efficiencies. We test the political interventions in investment and employment decisions. Our results provide strong support for the presence of investment inefficiencies and excessive employment amongst politically connected firms, whereas the detrimental effect of political interventions is substantially larger on employment decisions. We further find that such operational inefficiencies are more pronounced for low-growth connected firms. Finally, the economy-wide cost of the excessive employments is estimated to be 0.19 % of GDP annually.

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Notes

  1. Operational efficiency is the ability of a firm to produce its products in the most cost-effective manner possible while still ensuring the high quality of its products. In the current context, firms establish political connections to reduce the cost of resources required in production.

  2. We restrict ourselves only to observe altered employment size as an outcome of political interference. Unfortunately, the unavailability of data did not allow us to examine politically motivated hiring of inept employees that is also a significant aspect of political interference in employment decisions.

  3. Throughout this paper we use terms ‘operations’ and ‘activities’ interchangeably which refers only to firm investment and employment decisions.

  4. It is worth mentioning that we constrained ourselves to the investigation of the impact of political connections on investment and employment efficiencies and thereby calculating economy-wide cost caused by such operational inefficiencies. Our analysis does not examine the channels of political extraction—ways through which politicians distort the investment and employment efficiencies of the connected firms. These ways may include undertaking projects with negative NPV, hiring incapable employees or providing protection to unproductive labour which encourages them to keep doing so. Additionally, Boubakri et al. (2013) shows that politically connected firms undertake risky investments and we suspect that such pattern of risky investment decisions is also one of the channel which affects negatively on investment efficiency. The data unavailability on the variables involved did not allow us to examine these channels.

  5. Though cost of political connections also includes the cost of political donation, gifts, and bribes we confine ourselves only to ex post cost of political connections.

  6. This definition of investment expenditure is commonly used in corporate investment studies such as Ratti et al. (2008) and Gelos and Werner (2002).

  7. Data is available at the following URL: http://www.ecp.gov.pk/.

  8. We have the most firms from textiles and trade industry (132), followed by basic industries, including petroleum (67), and then construction (58).

  9. The results of Lagrangian multiplier (LM) test suggest that the cohort effect is zero and pooled regression is appropriate for estimating the employment model, whilst the random effect model is suitable for investment efficiency model. Further, the results of the Hausman test for investment efficiency model could not reject the null hypothesis, therefore implying that the random effects model outperforms the fixed-effects model.

  10. Recall that a negative sign on interactive term indicates that sensitivity of investment expenditure to investment opportunities, investment efficiency, is distorted by firm’s political connections.

  11. For instance, Ittafaq textile mills and Khalid Siraj textile mills, are owned by Nawaz Sharif (three times elected Prime Minister) located in his constituency in the city of Lahore. Similarly, Gujarat silk mill is connected to Chaudhry Pervaiz Elahi (Member of National Assembly) and is located in his constituency in the city of Gujarat.

  12. http://tribune.com.pk/story/522292/statistics-on-textile-industry-in-pakistan/.

  13. Sugar mills belong to Food and Tobacco industries.

  14. The importance of these two cities as the leading industrial hubs of country has been discussed in Rehman (2006).

  15. Employee investment mostly refers to capital investment that firms make in the workplace for employee inducement, such as pay, benefits, career opportunities (Romzek 1990).

  16. The pooled regression includes industry and time effects and R 2 of the estimation is 0.084.

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Authors and Affiliations

  1. Department of Management Sciences, COMSATS Institute of Information Technology, Park Road, Chak Shahzad, Islamabad, 44000, Pakistan

    Abubakr Saeed

  2. Cranfield School of Management, Cranfield University, Bedford, MK43 0AL, UK

    Yacine Belghitar

  3. Middlesex University, The Burroughs, Hendon, London, NW4 4BT, UK

    Ephraim Clark

Authors
  1. Abubakr Saeed
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  2. Yacine Belghitar
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  3. Ephraim Clark
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Correspondence to Abubakr Saeed.

Appendix

Appendix

See Table 11.

Table 11 Variable measurements
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Saeed, A., Belghitar, Y. & Clark, E. Political connections and firm operational efficiencies: evidence from a developing country. Rev Manag Sci 11, 191–224 (2017). https://doi.org/10.1007/s11846-015-0185-5

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