Politicians in the boardroom: Is it a convenient burden?

• Date: 01 November 2018
• Author: Rafel Crespí‐Cladera,Bartolomé Pascual‐Fuster
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/corg.12261

ORIGINAL MANUSCRIPT

Politicians in the boardroom: Is it a convenient burden?

Bartolomé Pascual‐Fuster |Rafel Crespí‐Cladera

Departament d'Economia de l'Empresa,

Universitat de les Illes Balears, Palma, Spain

Correspondence

Bartolomé Pascual‐Fuster, Departament

d'Economia de l'Empresa, Universitat de les

Illes Balears, Cra. de Valldemossa km 7.5,

Palma 07122, Spain.

Email: tomeu.pascual@uib.es

Funding information

Ministerio de Ciencia, Innovación y

Universidades, Grant/Award Numbers:

ECO2017‐86305‐C4‐1‐R and ECO2017‐

86903‐P; (MINECO/AEI/FEDER, UE)

Abstract

Manuscript Type: Empirical

Research Question/Issue: Our paper analyzes whether firms appoint former politi-

cians to relevant positions (Chair, Vice Chair, and Secretary) in the boardroom and on

the main delegated committees. We also analyze how former politicians perform in

their monitoring tasks as board directors.

Research Findings/Insights: We find evidence that the probability of having former

politicians in relevant positions on boards of directors and on the main delegated

committees is not different from that of the other directors. We also find that their

activity does not affect board performance in terms of CEO turnover control, execu-

tive director compensation, audit qualifications, and earnings management. It is only

when politicians serve as proprietary directors, representing large shareholders, or

as executive directors that we find some evidence that board monitoring performance

deteriorates.

Theoretical/Academic Implications: Our analysis suggests that the expected posi-

tive contributions predicted by resource dependence theory regarding the political

connections that are provided to the firm by former politicians serving as board direc-

tors do not generally imply higher agency costs due to weaker monitoring perfor-

mance. Our analysis provides a more comprehensive understanding of the

implications of resource dependence theory and of agency theory to explain politi-

cians' functions on boards of directors.

Practitioner/Policy Implications: We deliver a better understanding of the specific

implications of having politicians on boards of directors, providing guidance on how to

configure a board to maximize the value that politically connected directors provide.

Furthermore, regulators and investors should consider that the general interests of

shareholders may be better protected when former politicians serve as independent

directors. https://youtu.be/pBsOZIwqdAQ

KEYWORDS

corporate governance, board of directorscommittees, former politicians, monitoring, political

connections

1|INTRODUCTION

The literature documents that firms seek political connections (e.g.,

Cooper, Gulen, & Ovtchinnikov, 2010; Duchin & Sosyura, 2012;

Faccio, 2010; Fisman, 2001; Goldman, Rocholl, & So, 2009). In

developing countries, politicians and state bureaucrats have high

degrees of freedom in their decisions affecting firms, introducing a rel-

evant risk factor (e.g., Chen, Li, Su, & Sun, 2011). Resource depen-

dence theory (e.g., Pfeffer & Salancik, 1978) suggests that political

connections serve as a mechanism to control this source of risk.

Received: 3 May 2017 Revised: 11 August 2018 Accepted: 17 August 2018

DOI: 10.1111/corg.12261

448 © 2018 John Wiley & Sons Ltd Corp Govern Int Rev. 2018;26:448–470.wileyonlinelibrary.com/journal/corg

However, even in developed countries, which have higher scrutiny

and control over political decisions, such as the United States, there

is empirical evidence supporting the profitability of political connec-

tions (Cooper et al., 2010; Goldman et al., 2009). These connections

may take several forms, such as businesspeople entering politics, cam-

paign contributions, hiring politicians as board directors, and bribes.

Our study is centered on one form of political connection: politi-

cians' presence in firms' boardrooms, which is more frequent in larger

firms (e.g., Goldman et al., 2009). The literature argues that these

directors provide valuable knowledge to the firm and access to the

political system (e.g., Hillman, 2005; Lester, Hillman, Zardkoohi, &

Cannella, 2008). Consistently, the empirical evidence highlights the

political role played by politicians in the boardroom (Agrawal &

Knoeber, 2001, and Goldman et al., 2009, in the United States, and

Ye & Li, 2017, in China). However, board directors also have monitor-

ing functions (Adams & Ferreira, 2007), and less attention has been

paid in the literature to this role. There is empirical evidence, when

analyzing board meeting attendance, that politicians play passive roles

as monitors (Kang & Zhang, 2018, in the United States, and Ye & Li,

2017, in China) and that their presence as board directors has a nega-

tive effect (Shin, Hyun, Oh, & Yang, 2018) or no effect (Kang & Zhang,

2018) on the monitoring functions of the board of directors, such as in

CEO replacement decisions. Several articles find evidence of a trade‐

off between the advising and monitoring tasks of board directors

(e.g., Faleye, Hoitash, & Hoitash, 2011). Given politicians' valuable

advising, the trade‐off could explain their directing less effort and ded-

ication to monitoring tasks. If the monitoring function of a board dete-

riorates when politicians are in place, shareholders might incur costs

(opportunity costs), and the balance of the investment in the political

connection may even result in a decrease in shareholders' value. As

shown by Hadani, Bonardi, and Dahan (2017), in a meta‐analysis on

U.S. firms, investment in political connections is not always profitable

for firms, and there is a debate about the factors that determine

whether such investment is profitable.

Our article empirically analyzes to what extent former politicians

hold relevant positions in the boardroom and the effect on the moni-

toring functions of boards of directors. We analyze the former politi-

cians' participation in delegated committees and their relevant

positions on these committees and on the board (Chair, Vice Chair,

and Secretary). The allocation of a director to a specific position

implies some commitment to the tasks of this position. Therefore, by

analyzing the allocation of board positions among board directors,

we may obtain a signal of their commitments to perform both moni-

toring and advising functions. We may evaluate whether politicians

also perform monitoring tasks. These tasks may or may not be per-

formed diligently. Thus, we analyze the effects that former politicians'

presence on boards of directors, and the positions they hold, have on

specific controlling activities: the CEO turnover when firms

underperform, the executive directors' compensation practices, audit

qualifications, and the earnings management behavior.

The empirical analysis is performed on a sample of Spanish listed

firms. The principal‐principal agency theory considerations are rele-

vant in this context, where ownership is concentrated, and political

connections might facilitate power abuse by large shareholders (e.g.,

Chen et al., 2011, and Sun, Hu, & Hillman, 2016, in China), although

investor protection is stronger and politicians have less discretion

(power) than in developing countries. These institutional characteris-

tics of a country in the European Union make comparable the results

with other continental European countries, where listed firms also

have concentrated ownership structures. Our assumption is that polit-

ical connections are positively related to firms' value, as reported in

previous research on Spanish firms (Guerra‐Pérez, Bona‐Sánchez, &

Santana‐Martín, 2015).

Contrary to Kang and Zhang (2018) and toYe and Li (2017), we find

that politicians play relevant and active roles on the boards of directors

and in the delegated committees. Politicians hold relevant advising and

monitoring positions with the same frequency as other directors. Con-

sistent with Kang and Zhang (2018) in the United States, and contrary

to Shin et al. (2018) in Korea and to Ye and Li (2017) in China, we find

that the monitoring performance of the board of directors is not

affected by the presence of, or the positions held by, politicians on

the board of directors. Our results indicate that former politicians pro-

vide sound monitoring capabilities. Only when politicians are nominees

of large controlling shareholders or executives do we find some evi-

dence of a deteriorated monitoring by the board of directors. This result

suggests that, in the European context, there is no systematic trade‐off

between networking/advising and the monitoring functions of former

politicians. The low level of agency concerns found in our sample is

probably related to the overall development of the corporate gover-

nance system and to the regulation of politicians' involvement in corpo-

rate governance in the European institutional context.

Our analysis expands the literature on the functions of specific

types of board directors. Masulis, Wang, and Xie (2012) analyze inde-

pendent directors with residence in foreign countries, and Chen

(2008) analyzes independent directors who are executives in other

firms. Both obtain evidence that supports a trade‐off between the

monitoring and advising functions. However, our evidence suggests

that the functions are compatible. On the basis of the specific charac-

teristics of former politicians as board directors, we also contribute to

this literature by providing new arguments that favor compatibility

(e.g., Kim, Mauldin, & Patro, 2014). These arguments are based on for-

mer politicians' reputational concerns (Yermack, 2004), which might be

especially relevant, and also on the possibility of compatibility

between the advice they can provide, based on networking and

knowledge of the political arena, and tight monitoring.

Our findings also contribute to the literature on political connec-

tions (e.g., Agrawal & Knoeber, 2001; Goldman et al., 2009; Hillman,

2005; Kang & Zhang, 2018; Shin et al., 2018; Ye & Li, 2017) and to

the literature on the costs and benefits of such connections (e.g.,

Okhmatovskiy, 2010; Sun, Mellahi, Wright, & Xu, 2015; You & Du,

2012). We specifically show that former politicians are active board

members, providing also useful monitoring abilities to the firm, and

therefore do not generate costs to shareholders from deteriorated

monitoring by the board. Additionally, the institutional context of

our sample allows us to identify former politicians explicitly defending

the interests of controlling shareholders, and those serving as execu-

tives. Interestingly, both groups create some concerns in terms of

monitoring. However, more general agency costs are found in transi-

tion economies, such as Russia (Okhmatovskiy, 2010) and China

(You & Du, 2012).

PASCUAL‐FUSTER AND CRESPÍ‐CLADERA 449