Political connections, bailout in financial markets and firm value

Banerji, Sanjay and Duygun, Meryem and Shaban, Mohamed (2016) Political connections, bailout in financial markets and firm value. Journal of Corporate Finance . ISSN 0929-1199 (In Press)

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Abstract

The paper shows that politically motivated interventions in the financial market in the form of bailing out borrowing firms reduce banks’ incentives to gather valuable information about firms’ projects. This loss of information is a hidden cost which adversely affects firm value. Firms invest resources and pay a premium to politically connected persons (BOD or other personnel). Such connections serve the twin purposes of hedging and enhancement of the value of collateral pledged against bank loans. Feeling secured, banks lose incentives to monitor borrowing firms. Thus, wealth effect of bailout from political connection is partially offset by the losses of valuable information brought about by bank lending. In equilibrium, the trade-off from gains out of political connections and costs due to losses from information-based bank monitoring depend on (i) the country’s disclosure laws, (ii) the political environment, (iii) the premium paid to form connections, and (iv) the state of the economy.

Item Type: Article
Keywords: Bank monitoring, information production, Bailout, political connection
Schools/Departments: University of Nottingham, UK > Faculty of Social Sciences > Nottingham University Business School
Identification Number: https://doi.org/10.1016/j.jcorpfin.2016.12.001
Depositing User: Howis, Jennifer
Date Deposited: 08 Feb 2017 11:08
Last Modified: 09 Feb 2017 18:51
URI: http://eprints.nottingham.ac.uk/id/eprint/40414

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