Political Geography and Bank Loans

An increasing focus on firms’ political connection has been documented in corporate strategy literature. Firms get explicitly connected by hiring politicians as their board directors, or by making firm directors serve as politicians. Firms can also get implicitly connected by making political contributions. These connections have been established by firms’ active efforts to be connected for the purpose of enhancing firms’ benefits from connections.The recent literature documents the importance of geography on firm value. Kim, Pantzalis, and Park (2011) analyze a political dimension to geography and its impact on firm value. Firms whose headquarters are located in states more closely aligned with the party in the White House perform better than those firms located in states which are less closely aligned with the president’s party. This result can be interpreted as being consistent with the notion that firms with high alignment with the president’s party leads to higher policy risk (i.e., uncertainty related to the impacts of changes in government future policy and its implementation) which, in turn, results in higher future returns. Alternatively, their findings can also be interpreted that benefits from connections to the party in the White House causes an increase in cash flows and higher future returns.The main purpose of this proposal is to differentiate these two competing forces of policy risk and indirect political benefits in the context of firm’s access to private debt financing. This attempt is possible under debt financing but it is extremely difficult by studying cross-sectional variations in future returns of firms, because both explanations predict that firms with high political alignment outperform those with low alignment. Firms with high alignment is more susceptible to higher loan interest premium and more restrictive loan contracts, given the fact that policy risk could be translated into the downside risk of the bank loan. Benefit from indirect connections to the party in White House will induce a lower interest and fewer restrictive loan contracts, as opposed to the policy risk prediction.Given the scarce of the literature on the above-mentioned issue, our research will introduce political geography to loan literature and identify the possible link between them. Our research will also broaden the definition of political connectedness to include small-sized firms. Those direct political connections through human ties and contributions can be utilized by big-sized firms with more resources. However, geopolitics can be applied to all firms in a specific state.