The impact of political connection and risk committee on corporate financial performance: evidence from financial firms in Malaysia

• Date: 13 October 2020
• Pages: 1281-1305
• DOI: https://doi.org/10.1108/CG-04-2020-0122
• Published date: 13 October 2020
• Author: Redhwan Aldhamari,Mohamad Naimi Mohamad Nor,Mourad Boudiab,Abdulsalam Mas'ud

The impact of political connection and

risk committee on corporate f‌inancial

performance: evidence from f‌inancial

f‌irms in Malaysia

Redhwan Aldhamari, Mohamad Naimi Mohamad Nor, Mourad Boudiab and

Abdulsalam Mas’ud

Abstract

Purpose –This study aimsto examine the association between the effectiveness of risk committee(RC)

and firms’ performancein Malaysian context. It also exploreswhether political connection has an impact

on the relationship.

Design/methodology/approach –This study, using a principlecomponents analysis, derives a factor

score for RC attributes to proxy the effectiveness of RC. It also uses both accounting and market

performanceto measure the company performance.

Findings –Using a sample of financial firms from 2004 to 2018, this study finds t hat both accounting

and market performance are higher for firms with an effec tive RC. It also finds that the effectiveness

of RC in monitoring and management of risks is more pron ounced for politically connected firms

(PCFs). In further tests, the paper finds that RC att ributes (i.e. RC independence, qualification and

gender) are positively and significantly associated wit h accounting performance, while those of RC

existence and overlap arepositively and significantly related to market performance. The study also

finds that RC size (RC diligence) has a posit ive (negative) impact on financial firms accounting and

market performance.The further analysis also shows that PCFs with a separate as well as larger RCs

experience both higher accounting and market performance. Thi s study’s results are robust for

concerns of endogeneity.

Practical implications –The findings of this study resolve the ongoing debates surrounding political

connection by suggesting financial firms not to have politically connected board membersas doing so

may deteriorate their performance. This study’s results are also useful for investors, regulators and

policymakers.

Originality/value –To the best of the authors’knowledge, this study, for the first time, introduceson the

interaction term betweenthe effectiveness of RCs and political connection to empiricallyexplore how an

effective RC may reduce the potential riskof political ties. As such, this study adds to the literature and

sheds light on an aspect of risk (i.e. risk stems fromestablishing close link with the government) that is

growingin importance.

Keywords Political connection, Corporate performance, Financial institutions, Risk committee

Paper type Research paper

1. Introduction

The financial crisis, along with unexpected corporate failures and scandals, such as Enron,

WorldCom, Parmalat, Bear Stearns,Citigroup, Lehman Brothers and Dexia in the West, and

Transmile, Megan Media and Oilcorp in Malaysia, has raised awareness on the importance

of corporate governance mechanisms to monitor various types of risks (e.g. credit risk,

Redhwan Aldhamari,

Mohamad Naimi Mohamad

Nor and Mourad Boudiab

are all based at the Tunku

Puteri Intan Safinaz School

of Accountancy, Universiti

Utara Malaysia, Sintok,

Malaysia.

Abdulsalam Mas’ud is

based at the Department of

Taxation, Federal University

Dutse, Dutse, Nigeria.

JEL classif‌ication –M41, G21,

G28, G32, G34

Received 3 April 2020

Revised 3 June 2020

6 August 2020

Accepted 13 August 2020

The authors wish to thank

Hamid Al-Wesabi for his

valuable suggestion in the

analysis process and the

anonymous reviewers of this

paper. The authors report no

conflicts of interest and they

take responsibility for any errors

contained in this paper.

DOI 10.1108/CG-04-2020-0122 VOL. 20 NO. 7 2020, pp. 1281-1305, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1281

liquidity risk, information risk and principle risk) for financial institutions. Although there are

many factors that may have contributedto these financial crisis and corporate disasters, the

poor monitoring of risks which enabled the management to take excessive risk was a major

cause for these fragilities(Raber, 2003;Yeh et al., 2011;Battaglia et al., 2014).

Traditionally, risk management functions have been the responsibility of the audit committee

in most countries including Malaysia. However, the trust placed on the audit committee in

assessing risk-related activities and financial reporting is somehow challenged by

corporate collapses globally. The risks associated with company operations are wide,

comprising both financial and non-financial risks, which technically go beyond the scope of

an audit committee (Ng et al.,2013). Literature concludes that a traditional audit committee

is not adequate for overseeing and monitoring financial as well as non-financial riskin today

complex and high-risk environment (Brown et al.,2009;Yatim, 2010;Kallamu, 2015).

Moreover, the increase in the responsibilities imposed on the audit committee and the lack

of resources such as time and expertise required to provide effective oversight of

organisational risk management strategies have emphasised the need to establish a

separate risk committee (RC).

It has been suggested that the establishment of an RC will assist organisations inachieving

their objectives and secure the organisational reputation as well as provide improved

quality financial reporting. Moreover, according to the agency theory, the RC plays

important role in mitigating the conflict of interest between the shareholders and managers,

which may lead to enhanced shareholder value and firm performance. The extant literature

reports that an RC can ensure that managers do not avoid profitable but risky projects

which may reduce operational risk and ultimately enhance performance (Elamer and

Benyazid, 2018). As such, based on the agency theory, it is plausible to expect that

financial performance is improved in the presence of an effective RC that reduces

information asymmetry and operational as well as information risks.

There are two competing arguments as to the beneficial vs the detrimental role of political

connection. These arguments suggest that there may be countervailing effects of political

connection in accentuating or attenuating financial performance. Resource-based and

helping hand theory suggest that political connection facilities the chance for a firm to

generate benefits that are more likely to improve the performance of the firm. This is on the

fact that firms are priori likely to link themselves to the government or politicians as such

linkage provides economic benefits such as securing government contracts, government

bailouts, tax waivers, market power and government subsidies. Su and Fung (2013) argue

that cultivating political connections help firms to increase their sales and to incur lower

operation and financing cost, which may reflect favourably on the firms’ performance. A

review of literature indicates that politically connected firms (PCFs) experience high

financial performance (Niessen and Ruenzi, 2010;Wu et al.,2012;Ding et al., 2014;Zhang

et al.,2014

;Li et al., 2016;Wang et al., 2019). In line with this argument, one may expect

that an RC as a channel to improve a firm performance may be diluted in the presence of

political ties and, thus, the RC–performance association is weakened for PCFs.

On the other hand, establishingclose ties with the government may not always be beneficial

to a firm because, as argued by the agency theory, government officials seek different

objectives that may go against value-maximizing objectives. For example, government

officials may use firms’ resources to benefit their cronies and supports, who in return

provide votes, political contributions and bribes (La Porta et al., 2002;Bushman et al.,

2004). Squandering the firm’ resources in non-value maximizing activities may eventually

affect the company performance adversely. Moreover, grabbing hand theory alleges that

political connection may entrench the resource of the firm through systematic favours of

directors which may have the serious consequence of firm value. Extant literature shows

that PCFs are riskier, have poor governance practice and lower financial performance than

non-political affiliated firms (Fan et al.,2007;Asquer and Calderoni, 2011;Cao et al., 2011;

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