UNAIR experts study political connections and risk of stock price crash

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Illustration by Feri Fenoria

UNAIR NEWS – “Building political connections can generate benefits and costs for companies.” It was the opening statement of a research of Iman Harymawan, Ph.D. and team when reviewing “Political Connections and Stock Price Crash Risk in and after the Era of Soeharto”.

In his presentation he reviewed that in 1998, Indonesia was devastated by the financial crisis. The crisis began in Thailand and South Korea, then spread throughout Asia. The financial crisis, he continued, then developed into a political crisis that caused Suharto’s resignation after 32 years in power.

“The question arises, what about the condition of the companies which have connections with Soeharto at the time?” he said.

From the research, Iman explained that there are two possible correlations between politically connected companies and the risk of stock price crash. The first possibility, explained Iman, is that companies with political connections are more likely to greater risk. He also said that it was based on previous references which had found that politically connected companies can get significant benefits in terms of financing, while companies that are not politically connected are more likely to suffer from funding constraints.

“To meet the financial requirements, managers are encouraged to cover up financial statements and hide negative information. This action can lead to more information asymmetry, and the accumulation of bad news can ultimately lead to a crash of stock prices, “he said.

Furthermore, the results of research showed that political connection data were obtained from the Indonesia Capital Market Directory (ICMD) and information on the number of subsidiaries was obtained from the Osiris database. Accounting and financial data, he explained, were obtained from the Compustat Global database. In general, he continued, the results of the analysis showed that companies with political connections had lower risk of stock price crash.

“These findings showed that political connections can reduce the risk of company’s stock price crash. This negative association is more clearly seen in companies with more complex corporate structures, “he explained.

In the end, he reiterated that by using the difference-in-difference method, evidence was found that companies with political connections also had higher risk of stock price crash. It happened after Soeharto went down.

“These results implied that the costs of political connections arise only after these connections lose power,” he concluded.

Author: Nuri Hermawan

Editor: Khefti Al Mawalia

Reference:

https://www.mdpi.com/2227-7072/7/3/49/htm

Harymawan, I., Lam, B., Nasih, M., & Rumayya, R. (2019). Political Connections and Stock Price Crash Risk: Empirical Evidence from the Fall of Suharto. International Journal of Financial Studies, 7(3), 49.

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