Research Archive

Estimating the Value of Political Connections

Publication type: Journal article

Research Archive Topic: Business Economics and Public Policy, Capital Markets and Investments, Corporate Finance, Strategy, World Business

Abstract

As the Indonesian economy went into a downward spiral in the latter half of 1997, there was much speculation and debate as to the reasons behind the sudden decline. Most explanations gave at least some role to investor panic, which had led to a massive outflow of foreign capital. At the root of this hysteria, however, were concerns that the capital that had flowed into Indonesia and elsewhere in Southeast Asia had not been used for productive investments. Much of this discussion focused on the role of political connections in driving investment. The claim was that in Southeast Asia, political connectedness, rather than fundamentals such as productivity, was the primary determinant of profitability and that this had led to distorted investment decisions. Obviously, the degree to which this type of problem was truly responsible for the Asian collapse depends very much on the extent to which connectedness really was a primary determinant of firm value. In making the argument that this was in fact the case, anecdotes about the business dealings of President Suharto's children were often cited as evidence. Such stories suggest that the value of some firms may have been highly dependent on their political connections. Because of Indonesia's highly centralized and stable political structure (until the very end of Suharto's reign), it is possible to construct a credible index of political connectedness. Moreover, my "event study" approach described below allows for a relatively clean measure of the extent to which firms relied on these connections for their profitability.
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Citation

Fisman, Raymond. "Estimating the Value of Political Connections." American Economic Review 91, no. 4 (September 2001): 1095-1102.


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