Political connections, corporate governance and preferential bank loans

Abstract

The presidential election in Taiwan during 2000 resulted in the first political changeover in more than fifty years from the ruling party, the Kuomintang (KMT), to the Democratic Progressive Party (DPP). In 2004, the KMT was expected to win, but eventually lost to the DPP. We use these two exogenous events to investigate three issues: how political connections are related to preferential bank loans, how the entrenched position of the ruling party affects the types of preferential bank loans and how corporate governance is related to preferential bank loans. We find that KMT-connected (DPP-connected) firms were associated with higher (lower) abnormal returns before the 2004 election. This pattern of returns was reversed after the unexpected result. Moreover, we find that political connections were positively correlated with preferential bank loans. However, the types of preferential bank loans differed between KMT-connected and DPP-connected firms due to differences in the entrenched power of the ruling party. Finally, we find that corporate governance is negatively correlated with preferential bank loans, probably because firms with good corporate governance have more alternative financial sources. © 2012 Elsevier B.V.