Political connections, overinvestment, and governance mechanisms in Indonesia

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Illustration of political connections. (Source: SpaceStock article)

The issue of political connections in companies is interesting to discuss because companies with political connections are indicated to have several advantages, so it is not uncommon for these political connections to be misused for personal gain and bring down other parties. A study was conducted to assess companies in Indonesia, because Indonesia is a country with a democratic and multi-party system. Indonesia has a lot of political parties and tends to have a high political turnover as well, thus, there is a great possibility of political connections in Indonesia may not provide stable benefits for related parties because it depends on the era of the presiding president. Therefore this study looks at the impact of political connections on overinvestment in Indonesia, and how corporate governance mechanisms affect these relationships.

Political connections and overinvestment

Companies with political connections are indicated by the presence of majority shareholders or members of top management with a position in government or are closely related to politicians. This research will focus on the background of political connections held by the board of directors, board of commissioners, and corporate audit committee. With a political connection, a company’s investment policy is influenced by government policy.

Indonesia as a developing country has a democratic and multi-party political system, which the political conditions are far different from the political conditions from research conducted in China. So the benefits gained through this political connection will be different. In terms of the economy, there is a mixed system between the private sector and government that both have a significant role in Indonesia.

Furthermore, regulations regarding investment decisions in Indonesia are still concentrated on individual investors, and there are no significant regulations to govern investment policies among companies. So that investment inefficiencies triggered by agency problems can occur, where companies can experience overinvestment, which is characterized by investment spending that exceeds the expected amount or underinvestment, which is characterized by less investment expenditure compared to the number of expectations.

Governance mechanisms and correlation between political connections – overinvestment

The mechanism of good corporate governance from internal and external aspects is very important to overcome the managerial problems in the company, because the presence of external parties will help realize and overcome the possibility of management information problems with a different perspective. With the composition of independent board of directors, it can mitigate the negative effects that may be caused by the company’s internal management. In relation to the problem of overinvestment, governance mechanisms in a company can affect the level of investment activity in a company, so it is expected to mitigate the occurrence of overinvestment.

Method and Results

The data used are data of Indonesian companies listed on the Indonesia Stock Exchange in 2012-2017, except for financial company data. Overinvestment measurements are carried out in two ways, first determining the residual value either positive or negative as overinvestment, and second determining if the residual value is positive then overinvestment, and negative value then underinvestment. The used final sample consisted of 1,044 companies for the first measurement, and 543 companies for the second measurement sample. Furthermore, to analyze the results, this study uses OLS Regression and Coarsened Exact Matching Regression to strengthen the results and ensure that the groupings of observation groups are random.

The results showed that political connections in the company have a significant negative association with overinvestment in the company. Significant results occur in both models of overinvestment measurement. Furthermore, this study found that governance mechanisms from outside and within the company did strengthen the negative association between political connections and corporate overinvestment in Indonesia. It happens because the existence of an independent board of directors and auditors by the Big Four Company effectively mitigate the adverse effects of overinvestment.

Author: Iman Harymawan,

Details of the research available at

https://www.tandfonline.com/loi/oaef20

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