Leuz - Gee 2006 JFEC PDF

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Journal of Financial Economics 81 (2006) 411–439

www.elsevier.com/locate/jfec
Political relationships, global financing, and

corporate transparency: Evidence from Indonesia$
Christian Leuza,, Felix Oberholzer-Geeb
a
The Wharton School, University of Pennsylvania, Philadelphia, PA 19104, USA
b
Harvard Business School, Harvard University, Boston, MA 02163, USA
Received 8 September 2003; received in revised form 4 May 2005; accepted 22 June 2005
Available online 20 February 2006
Abstract
This study examines the role of political connections in firms’ financing strategies and their long-
run performance. We view political connections as an example for domestic arrangements which can
reduce the benefits of global financing. Using data from Indonesia, we find that firms with strong
political connections are less likely to have publicly traded foreign securities. As a result, estimates of
the performance consequences of foreign financing are severely biased if value-creating domestic
arrangements such as political relationships are ignored. Connections not only alter firms’ financing
strategies, they also influence long-run performance. Tracking returns across several regimes, we
show that firms have difficulty re-establishing connections with a new government when their patron
$
We thank two anonymous reviewers, Michael Backman, Phil Berger, Jack Coffee, Alexander Dyck, Mara
Faccio, Ray Fisman, Tarun Khanna, Greg Miller, Todd Mitton, DJ Nanda, Jordan Siegel, Benny Tabalujan,
Ross Watts, Greg Waymire, Peter Wysocki, and Jerry Zimmerman, as well as seminar participants at the AEA
Annual Meeting, Chinese University of Hong Kong, EAA Annual Meeting, Harvard Business School, Norwegian
School of Economics and Business, Singapore Management University, Stanford Summer Camp, University of
Rochester, Stockholm University, and the Wharton School for helpful comments. We are grateful to Simeon
Djankow and Ray Fisman for sharing data. Arief Budiman, Shanshan Cao, Bryan Chao, Christina Hsiung Chen,
Robert Irwan, Randy Jusuf, Ian Lin, Svetlana Ni, and Julie Wong provided excellent research assistance. The
generous financial support of the Wharton–Singapore Management University Research Center and the Baker
Foundation is gratefully acknowledged.
Corresponding author. Tel.: +1 215 898 2610; fax: +1 215 573 2054.
E-mail address: leuz@wharton.upenn.edu (C. Leuz).
0304-405X/$ - see front matter r 2006 Elsevier B.V. All rights reserved.
doi:10.1016/j.jfineco.2005.06.006
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412 C. Leuz, F. Oberholzer-Gee / Journal of Financial Economics 81 (2006) 411–439
falls from power, leading closely connected firms to underperform under the new regime and
subsequently to increase their foreign financing.
r 2006 Elsevier B.V. All rights reserved.
JEL Classifications: P16; G32; G38; K22; K42; M41; G18
Keywords: Cross listing; Financing choices; Emerging markets; Asian financial crisis; Indonesia; Disclosure
1. Introduction
Political connections are believed to be a valuable resource for many firms (Fisman,
2001), but there are only a handful of studies that document how such connections impact
firms’ strategic choices and their long-run financial performance (Faccio, 2002; Johnson
and Mitton, 2003). Studying the performance consequences of political ties is of particular
interest because these ties are often inconsistent with other value-creating business
strategies. Moreover, the performance of closely connected firms might vary dramatically
over time depending on the political fortunes of their backers, suggesting that connection-
based strategies could be particularly risky. In this study, we analyze how closely
connected firms make strategic decisions and how these decisions affect their long-run
financial performance.
In the first part of the paper, we examine the link between political ties and firms’ global
financing strategies. We are interested in this link because foreign capital has become an
increasingly important source of finance for firms in emerging markets (e.g., Karolyi, 1998;
Bekaert et al., 2002). Empirical studies find that companies that access global capital
markets experience substantial benefits. For instance, firms with U.S. cross-listings enjoy a
lower cost of capital, improved visibility and reputation, and better growth opportunities
(e.g., Errunza and Miller, 2000; Doidge et al., 2004; Hail and Leuz, 2004).
Taking these benefits at face value, it is difficult to understand why only a minority of
companies access foreign capital markets. A core idea in this paper is that domestic
opportunities significantly reduce the net benefits of foreign securities for some firms. For
instance, firms with political ties often receive cheap loans from state-owned banks
(Faccio, 2002; Wiwattanakantang et al., 2006), so they do not need to tap into foreign
capital markets. It is also possible that global financing imposes extra costs on
closely connected firms because the decision to cross-list shares on foreign exchanges
often forces firms to adapt to the regulations that govern these markets (Coffee, 2002;
Reese and Weisbach, 2002; Siegel, 2005). If minority shareholders are better protected
abroad, issuing foreign securities becomes expensive for controlling owners accustomed
to exploiting domestic investors. Similarly, firms with foreign securities attract the
attention of foreign analysts and the international business press (Baker et al., 2002;
Lang et al., 2003). However, high levels of public scrutiny can be difficult to reconcile
with political favors of often dubious legality. These hidden costs of foreign financing
can perhaps explain why few companies finance themselves globally despite the apparent
benefits of doing so. While this study is focused on political connections, we believe
the hidden costs of global financing to be significant in many contexts. Political patronage
is just one example of domestic arrangements that reduce the net benefits of having
foreign securities.
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C. Leuz, F. Oberholzer-Gee / Journal of Financial Economics 81 (2006) 411–439 413
We examine the link between political connections and global financing using
Indonesian data. Indonesia’s crony capitalism under former President Suharto provides
a particularly suitable setting for examining the role of connections for firms’ foreign
financing choices. There is ample evidence that political connections were particularly
valuable under the Suharto regime and often involved access to finance (Borsuk, 1993;
McBeth, 1994; Fisman, 2001). Moreover, Indonesia has low levels of mandatory
disclosure, suggesting that publicly traded foreign securities have substantial informational
consequences. Finally, the Asian financial crisis and subsequent regime changes provide
shocks that we can exploit in assessing the performance consequences of foreign financing
and political connections.
Our results provide strong support for the view that foreign securities and close political
connections are substitutes. Firms that were close to the Suharto regime were significantly
less likely to have publicly traded securities abroad. These findings hold after controlling
for firm size, financial leverage, profitability, and industry characteristics. We carefully test
for the possibility that our findings are due to unobserved heterogeneity among the sample
firms. Using an instrumental-variable strategy, our closeness measure does not appear to
be endogenous to the choice of foreign securities. We also demonstrate that our results are
robust to alternative proxies for political connections and are not driven by company
differences in volatility, susceptibility to bad news, dependence on external financing, or
exposure to foreign product markets.
Our finding that political relationships influence the likelihood of global financing has
important implications for studies estimating the performance effects of foreign securities.
Recent papers show that Asian firms with foreign securities, higher-quality disclosures, and
less problematic ownership structures exhibit significantly higher returns during the Asian
financial crisis (Johnson et al., 2000; Mitton, 2002; Lemmon and Lins, 2003; Baek et al.,
2004). However, if domestic sources of firm value are omitted from these analyses, the
resulting estimates are likely to be biased. In a re-analysis of returns during the crisis, we do
indeed find significant bias in simple performance regressions that fail to control for
political connections. Conceptually, this bias provides empirical evidence that, during the
crisis, President Suharto was propping up firms that were close to his regime.1 The analysis
also illustrates why it is important to consider the endogeneity of foreign financing
decisions and hence firms’ domestic opportunities when estimating performance benefits.
The second part of the paper is concerned with the long-run consequences of
investments in political relationships. Unlike many other resources at the firm’s disposal,
political connections can lose their value overnight when the government fails to win an
election, suggesting that investments in political relationships might be particularly risky.
On the other hand, many formal models of political economy assume that politicians
auction off favors to firms with the highest willingness to pay for political patronage
(Bernheim and Whinston, 1986). Under this view, well-connected managers can easily re-
build their relationships once a regime has changed, and regime changes have little effect
on long-run firm performance.
1
While empirical support for propping is still rare, there is ample anecdotal evidence that Suharto tried to
protect well-connected firms. For example, the Texmaco group received loans in excess of US$ 1 billion from
Bank Negara Indonesia, one of Indonesia’s largest state banks. The loans far exceeded the bank’s legal lending
limit, but were approved by Suharto ‘‘as a means to prop up the conglomerate after the Asian financial crisis.’’
Texmaco’s founder, Marimutu Sinivasan, is said to be a long-time friend of President Suharto (Solomon, 1999).
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Indonesia provides ample opportunity to study the performance consequences of

regime changes. After the long-lived Suharto regime and its sudden demise on 21 May
1998, President Habibie, a long-time Suharto ally, took office. In October 1999,
Habibie was replaced by President Wahid, a cleric critical of the Suharto regime
(Symonds, 1998). These regime changes allow us to study both a friendly transition,
when Suharto’s protégé Habibie came to power, and the inauguration of the Wahid
government which treated the Suharto cronies less favorably. Studying the financial
consequences of such changes, we find that firms closely connected to Suharto
underperformed during the Asian financial crisis as long as Suharto was in power;
recovered under Habibie; but significantly underperformed once Wahid took office. This
pattern of changes in long-run financial performance suggests that it was not easy for
companies connected to the Suharto regime to establish close connections with the new
and less friendly Wahid government.
If the empirical regularity documented in the first part of this study—that closely
connected firms shy away from global financing—holds generally, Suharto firms should
have found it more attractive to finance their operations globally once Wahid came to
power. In an empirical analysis of the Wahid period, we document that former Suharto
cronies became more inclined to issue foreign securities. This set of results has important
implications for the consequences of financial liberalization because it suggests that there
are important complementarities between capital market liberalization and political
reform (Chui et al., 2000; Stulz, 2005). Firms closely connected with the Suharto regime
chose not to access global capital markets because the benefits of global financing
remained small for these firms as long as they benefited from political connections. Once
the connections had lost their value, raising capital abroad became more attractive.
Changes in financing strategies reflect changes in the domestic opportunities that firms
must forgo when they issue foreign securities.
This paper contributes to the literature on global financing and the benefits of
cross-listing by developing a more complete model of financing choices (e.g., Saudagaran,
1988; Saudagaran and Biddle, 1995; Karolyi, 1998; Doidge et al., 2004). An appealing
feature of this model is that it is easier to understand why the vast majority of large
firms do not access global capital markets even though the group of globally financed
companies experiences substantial benefits. Our study also complements the literature
on the importance of political connections by documenting that close political ties
have important consequences for firm strategy and performance (Stigler, 1971; Kroszner
and Strahan, 1999; Baron, 2001; Faccio, 2002; Johnson and Mitton, 2003; Friedman
et al., 2003). Political ties affect firm performance in two ways. In the short run, firms
with close connections underperformed during the Asian financial crisis. In the long
run, investments in political relationships stopped paying off because a new, less
friendly government came to power. Investments in political ties, we conclude, are
less likely to be a source of long-term value in environments with macroeconomic and
political instability.
The paper is organized as follows. Section 2 describes the institutional setting of this
study. Section 3 explains the sample and the data. In Section 4, we present the main results
for firms’ foreign financing decisions. Section 5 explores whether our results are specific to
the type of foreign security that we study. In Section 6, we analyze the performance effects
of foreign securities. In Section 7, we explore the dynamics of political connections, and
Section 8 concludes the paper.
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2. Institutional setting
A key premise of our approach is the idea that political connections constitute a source
of firm value. There is empirical evidence supporting this view, both for Indonesia
(Fisman, 2001) and for a larger set of economies. For instance, connected firms pay lower
taxes and have larger market shares (Faccio, 2002). In Indonesia, the Suharto regime often
arranged preferential financing for well-connected firms (so-called ‘‘memo-lending’’). An
example from the early 1990s is Golden Key, a little-known chemical and manufacturing
group, which received an unsecured loan of $430 million from the state-owned Bank
Pembangunan Indonesia. Court proceedings subsequently revealed that Hutomo Mandala
Putra, the youngest son of President Suharto, was an early investor in Golden Key and had
introduced the firm to bank officials who approved the loan at ‘‘neck-breaking speed’’
(McBeth, 1994). Similarly, the Barito Pacific group received huge loans from state banks
prior to the Asian financial crisis. Political connections were widely cited as the reason
behind the state banks’ generosity (Borsuk, 1993).
The benefits of political connections are not confined to debt financing. Barito Pacific’s
1993 Indonesian stock offering, for instance, was greatly helped by the state civil service
pension fund acquiring a 20% stake. Barito denied allegations that it needed the pension
fund’s entry to ‘‘shore up the company before it could go public,’’ but analysts noted that
the fund’s investment substantially boosted the company’s capital (Borsuk, 1993). A
further source of value for politically well-connected firms is the granting of important
licenses. The Salim Group, one of the largest Indonesian conglomerates, had very close ties
to President Suharto and was awarded lucrative franchises in banking, flour milling, and
telecommunications (Shari, 1998). These anecdotes illustrate that political connections are
a way to obtain low-cost financing and other economic advantages.
An alternative strategy to increase firm value is to access foreign capital markets. The
issuance of foreign securities can lower the cost of capital, help overcome the obstacles of
segmented markets (Stulz, 1981, 1999; Errunza and Miller, 2000), and increase the firm’s
value by fostering its recognition among analysts and investors (Merton, 1987; Lang et al.,
2003). Some authors have also argued that U.S. cross-listings improve corporate
transparency, investor protection, and hence the value of the firm to outsiders. This claim
is the subject of an ongoing debate.2 Coffee (1999, 2002), Mitton (2002), Reese and
Weisbach (2002), and Doidge et al. (2004) argue in favor of the hypothesis. Fanto (1996),
La Porta et al. (2000), Licht (2001), and Siegel (2005) are more skeptical.
In assessing the performance and governance effects of global financing strategies, it is
important to understand why firms choose to issue foreign securities. The incentives to do
so depend in part on the relation between the value of access to foreign capital markets and
firms’ political relationships. A priori, it is not obvious whether firms with strong political
connections are more or less likely to access global capital markets. As close political ties
afford more attractive business opportunities, closely connected, fast-growing firms with a
high demand for capital might find it particularly attractive to tap into foreign markets.
Well-connected firms might also be the most interesting investment opportunities for
2
Our analysis highlights that domestic opportunities, such as political connections, are important when
estimating the benefits of legal bonding, but it does not contradict or support the bonding hypothesis. We also do
not analyze whether politically connected firms are more or less likely to expropriate outside shareholders, which
is a separate issue (see Cheung et al., 2005, for the link between connections and expropriation).
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foreign investors. These arguments suggest that close political ties and access to foreign
capital markets are complements.
On the other hand, there appear to be equally valid reasons to believe that firms with
stronger political relationships are less likely to raise capital globally. Low-cost financing
from state-owned banks makes it less attractive to tap into foreign markets, and the
additional scrutiny that comes with publicly traded foreign securities could be particularly
costly to firms with close political ties. Moreover, high levels of transparency and public
attention might expose political favors of questionable legality. For instance, firms in
weakly regulated markets are often free to engage in undisclosed related-party transactions
benefiting controlling insiders and political backers. Transactions of this type would have
to be reported if the firm’s securities trade on a major U.S. exchange. These arguments
suggest that political connections and global financing are substitutes. In view of the
conflicting arguments, the relation between firms’ financing strategies and their political
connections is ultimately an empirical question.
To examine this question, we analyze the likelihood of Indonesian firms having publicly
traded foreign debt or equity securities. We focus on publicly traded securities because they
are likely to subject firms to additional scrutiny by foreign investors, financial analysts, and
the business press. We also study which firms have debt or equity securities traded on
major U.S. exchanges, such as NYSE or NASDAQ. Firms with exchange-traded securities
have to file Form 20-F with the SEC, which requires extensive disclosures (e.g., on related-
party transactions) and a reconciliation of foreign financial statements to U.S. GAAP.
By virtue of filing with the SEC, firms are also subject to SEC enforcement, legal
threats from shareholders, and the provisions of the Foreign Corrupt Practices Act, under
which most SEC enforcement actions are brought (Coffee, 2002; Siegel, 2005; Karpoff
et al., 2005).
Having gained a better understanding of the tradeoff between political relationships and
foreign financing, we turn to the performance consequences of these strategic choices. We
first ask whether firms with foreign securities outperformed other companies during the
Asian financial crisis. The 1997/1998 crisis is widely seen as a crisis of confidence, and it is
interesting to investigate whether firms with foreign securities outperformed other
companies during this period (Mitton, 2002). Next, we look beyond the immediate crisis
to study the long-run consequences of investments in political relationships. We are
particularly interested in the performance of the Suharto cronies under President
Abdurrahman Wahid. Wahid ran on an anti-establishment platform, promising to end
cronyism in Indonesia. He ordered the arrest of Tommy Suharto, the son of the former
president, and refused to pardon Tommy when he pleaded for clemency to avoid an 18-
month prison sentence for corruption (BBC, 2000). The Wahid presidency thus affords the
opportunity to study the performance consequences of political ties when a less friendly
government comes to power.
3. Sample and data
We begin our sample construction with a worldwide search for foreign securities issued
by Indonesian firms. To compile our data, we use the databases of Datastream,
Bloomberg, Global Access, and SDC as well as the SEC filings on Edgar, lists of foreign
listings from major international stock exchanges, and the ADR lists provided by the Bank
of New York and Citibank. Based on this extensive search, we identify 22 firms with
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publicly traded debt and equity securities as of June 30, 1997, shortly before the beginning
of the Asian crisis. This count does not include foreign securities that are private debt
agreements or private equity placements because these arrangements allow investors to be
informed via private channels rather than through public disclosure. We separately analyze
these securities in Section 5.
Our tests require financial statement and share price data. We obtain financial data from
the Worldscope database for the 22 firms with foreign securities as well as all remaining
Indonesian firms covered by Worldscope in 1997. This search results in a sample of 151
firms. We hand-collect financial information from the Indonesian Capital Market
Directory (1997) and firms’ annual reports if the necessary financial data are missing in
Worldscope. We lose 13 firms because we are unable to find share price data on
Datastream. In addition, we drop eight firms that are not traded over our sample period.
Thus, the final sample consists of 130 firms, representing over 80% of the Indonesian
market capitalization in December 1996.
Our measure of political connections is based on Fisman (2001). His study shows that
firms that were close to Suharto suffered negative returns when bad news about the
President’s health hit the stock market. Based on this result, we compute for each firm a
cumulative stock return over the six health-related news events identified by Fisman. The
event days are January 30–February 1, 1995; April 27, 1995; April 29, 1996; July 4–9, 1996;
July 26, 1996; and April 1–3, 1997.3 The cumulative return is on average 4.6% and
exhibits considerable cross-sectional variation. Some firms lost more than 20% of their
value over these six events. We multiply the cumulative returns by 1 so that larger
realizations indicate greater closeness to Suharto. This variable is our main proxy for
political connections.
Table 1 reports descriptive statistics for our sample firms. All financial statement data
are measured as of the fiscal year-end in 1996. As expected, firms with publicly traded
foreign securities are significantly larger than those without such securities. They are also
more capital intensive and have more long-term debt. Both groups exhibit similar
accounting returns on assets for fiscal 1996.
4. The choice of foreign securities
4.1. Main results
We begin our analysis by studying firms’ decisions to have publicly traded foreign
securities. In our empirical model, the net benefit of foreign securities yi depends on a
vector of firm characteristics, Xi, the closeness to the Suharto regime, Ci, and industry fixed
effects, ms :
yi ¼ X i b þ gC i þ ms þ ei . (1)
If firms with closer connections to Suharto are less likely to have foreign securities, we
observe go0. Prior studies identify firm size and the export level of a firm’s industry as
3
For further details on the events see Fisman (2001). There are seven firms for which we do not have return data
for all six events. Dropping these firms does not materially alter our results or inferences. The results are also very
similar using the average rather than the cumulative return over the six events.
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Table 1
Summary statistics for the variables in the analysis
The table reports means and standard deviations (in parentheses) for a sample of 130 Indonesian firms and a
subsample of 22 firms with publicly traded foreign equity securities as of June 1997 and foreign debt securities that
mature in or after 1996. ‘‘Closeness to Suharto’’ is the log stock return over six news events indicating that
President Suharto is in bad health, multiplied by –1. ‘‘Closeness to Suharto (resignation)’’ is the log stock return
prior to and at Suharto’s resignation (5/12/1998–5/21/1998), multiplied by –1. ‘‘Suharto family-owned or SOE’’ is
a binary variable that is equal to one if Suharto, his wife, or any of their children were important owners, or if the
firm is state-owned. The variable is also coded as one if another company in our dataset, which was itself owned
by the Suharto family, is listed as an important owner. Information on the seven most important owners comes
from the Indonesian Capital Market Directory and from Worldscope. Firm characteristics are measured at the
end of fiscal year 1996. ‘‘ROA’’ is the ratio of operating income to total assets. ‘‘Capital intensity’’ is the ratio of
fixed assets to total assets. ‘‘Financial leverage’’ is the ratio of long-term debt to total assets. ‘‘Age’’ is the number
of years since the firm’s incorporation. ‘‘External financing needs’’ is the firm’s actual asset growth rate minus the
maximum growth rate that can be financed if a firm relies only on its internal resources and maintains its dividend,
as suggested by Demirgüc-Kunt and Maksimovic (2002). ‘‘President Director’’ indicates whether the head (CEO)
of the managing board of directors is Chinese ( ¼ 1). ‘‘Volatility’’ is the standard deviation of the weekly stock
returns during 1996. ‘‘Pre-crisis returns’’ and ‘‘Crisis returns’’ are annualized log stock returns for the periods
indicated in the table. ‘‘Days with bad news from Hong Kong (Singapore)’’ is the cumulative returns on the worst
five trading days for the Hang Seng Index (Strait Times Index) between January 1995 and April 1997. ‘‘Days with
large exchange rate fluctuations’’ is the sum of the absolute returns over the three days with the most positive and
the three days with the most negative changes in the rupiah–dollar exchange rate. ‘‘Days with large positive
exchange rate fluctuations’’ is the cumulative returns over the five days with the most positive changes in the
rupiah–dollar exchange rate. We denote statistically significant differences between the two subgroups as follows:
y
significant at 10%, *significant at 5%, **significant at 1% (using a nonparametric Wilcoxon test).
Full sample (N ¼ 130) Firms with foreign Firms w/o foreign securities
securities (N ¼ 22) (N ¼ 108)
Closeness to Suharto 0.072 0.058 0.075

(0.107) (0.040) 0.116)
Closeness to Suharto 0.109 0.009 0.129
(resignation) (0.208) (0.125) (0.216)**
Suharto family owned 0.092 0.182 0.074
or SOE (0.291) (0.395) (0.263)
Total assets 2390 6430 1570
(millions of Rupiah) (4990) (8730) (3320)**
ROA 0.068 0.070 0.068
(0.069) (0.055) (0.072)
Capital intensity 0.340 0.422 0.324
(0.237) (0.244) (0.233)y
Financial leverage 0.190 0.292 0.169
(0.168) (0.145) (0.165)**
External financing needs 0.224 0.368 0.193
(0.425) (0.493) (0.405)
Age 24.346 26.182 23.972
(13.806) (14.090) (13.784)
President Director is 0.585 0.591 0.583
Chinese (0.495) (0.503) (0.495)
Volatility 0.062 0.060 0.062
(0.026) (0.036) (0.024)
Pre-crisis log returns 0.267 0.135 0.294
7/1/96–6/30/97 (0.420) (0.346) (0.430)
Crisis log returns 1.353 1.077 1.410
7/1/97–8/31/98 (1.153) (0.849) (1.200)
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Table 1 (continued )
Full sample (N ¼ 130) Firms with foreign Firms w/o foreign securities
securities (N ¼ 22) (N ¼ 108)
Cumulative returns on days

With bad news from 0.034 0.046 0.031
Hong Kong (0.124) (0.057) (0.134)
With bad news from 0.063 0.086 0.059
Singapore (0.100) (0.083) (0.103)y
With large exchange 0.138 0.172 0.131
rate fluctuations (0.112) (0.125) (0.109)
With large positive 0.011 0.002 0.013
exchange rate (0.075) (0.066) (0.076)
fluctuations
Industry classification
Agriculture 0.038 0.045 0.037
(0.193) (0.213) (0.190)
Mining 0.015 0 0.019
(0.124) (0.135)
Manufacturing 0.508 0.545 0.500
(0.502) (0.510) (0.502)
Transport 0.062 0.091 0.056
(0.241) (0.294) (0.230)
Trade 0.092 0.091 0.093
(0.291) (0.294) (0.291)
Finance 0.238 0.227 0.241
(0.428) (0.429) (0.430)
Services 0.046 0 0.056
(0.211) (0.230)
important factors influencing the decision to cross-list shares abroad (Saudagaran, 1988;
Saudagaran and Biddle, 1995; Karolyi, 1998). A basic specification therefore controls for
industry effects and firm size, measured by total assets (model 1).4 Firms’ financing needs
and profitability can also influence their inclination to tap into global capital markets. We
add to the base model capital intensity and return on assets as proxies for financing needs
and profitability, respectively (model 2). The former is computed as the ratio of fixed assets
to total assets, and the latter is measured as the ratio of operating income to total assets.
Another control variable, which is frequently used in the literature, is financial leverage
(Healy and Palepu, 2001; Johnson and Mitton, 2003). We compute leverage as the ratio of
long-term debt to total assets (model 3).
The net benefit of foreign securities yi is unobserved, but we know which firms have such
securities:
(
1 if yi 40;
yi ¼ (2)
0 if yi p0:
4
Using the market value of equity as a proxy for firm size yields even stronger results, but we use total assets
because market capitalization is likely affected by firms’ financing and capital structure choices.
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Given the binary nature of our dependent variable, we present probit estimates in
Table 2. Standard errors in parentheses are clustered on business group affiliation to
account for the possibility that within-group financing strategies might be correlated
(Khanna and Palepu, 2000; we use affiliation data from Claessens et al., 2000; Fisman,
2001). The models explain a substantial fraction of the cross-sectional variation in firms’
foreign financing choices. The key result is that firms with strong political connections are
less likely to have foreign securities. The estimated coefficient in the first specification of
Table 2 implies that increasing closeness to Suharto by one standard deviation reduces the
likelihood of a firm having foreign securities by about five percentage points.
The result that political connections and foreign securities are negatively associated
continues to hold in the extended models 2 and 3 where we control for firm profitability
(ROA), financing needs (capital intensity), and financial leverage. The results remain
similar if we use other proxies for financing needs and profitability, namely average sales
growth and EBITDA over total assets (not tabulated). We also control for a firm’s average
trading volume over the event days to address the concern that infrequent trading of some
stocks could affect our results by biasing the Suharto measure towards zero; but including
trading volume leaves our results virtually unchanged. Eleven firms in our sample are
subsidiaries and affiliates of foreign firms. Because the tradeoff between domestic political
benefits and foreign financing could be different for these firms, we drop them to test the
robustness of our results (model 4). As before, we find that firms with better political
connections are less likely to have foreign securities.
A valid measure of political connections is critical for this study. To see if our
results hinge on a particular definition of political connections, we examine two alter-
native proxies for the closeness to Suharto. The first is firms’ stock returns during
the days leading up to Suharto’s resignation in 1998. The idea is that corporations close to
Suharto were likely to have experienced negative returns when he resigned. It is not clear
at which point the stock market expected Suharto to step down.5 To compute resignation
returns, we chose to accumulate returns over the period from May 12 through May 21,
1998. We use this cumulative return, multiplied by 1, along with all our controls in
model 5. We continue to find that more closely connected firms are less likely to have
foreign securities.
We also code a direct, family based measure for close connections. We use information
on the identity of the seven most important owners of the firms in our data set to create a
binary variable that is one if Suharto, his wife, or any of their children were important
owners. The variable is also coded as one if another company in our data set, which was
itself owned by the Suharto family, is listed as an important owner. In addition, we include
state-owned enterprises because they were directly controlled by the president. As
expected, companies that were owned by members of the Suharto family are less likely to
have foreign securities (model 6 in Table 2). That said, there is good reason to believe that
the family parameter is biased downward. The Suharto family maintained a complex web
of connections and hid many of its assets. This is one of the reasons why subsequent
Indonesian governments found it difficult to prove charges of cronyism and corruption
(Center for Public Integrity, 2005). However, in the specification with the family indicator,
5
On May 12, student protests calling for Suharto’s resignation gained momentum and widespread support. On
May 15, a wing of the ruling Golkar party called for his resignation. The upper house of the Parliament joined
these calls on May 18 (Cohen, 1998; DJ Newswire, 5/18/1998). Suharto finally resigned on May 21.
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Table 2
Foreign securities and political connections
The table reports probit estimates of the likelihood that the 130 Indonesian firms in our sample have publicly
traded foreign securities. The dependent variable takes on a value of one if the firm has foreign securities and zero
otherwise. ‘‘Closeness to Suharto’’ is the log stock return over six news events indicating that President Suharto is
in bad health, multiplied by –1. ‘‘Closeness to Suharto (resignation)’’ is the stock return prior to and including
Suharto’s resignation (5/12/1998–5/21/1998), multiplied by –1. ‘‘Suharto family owned or state-owned enterprise’’
is a binary indicator, which is 1 if Suharto, his wife, any of their children, or another company that itself is owned
by the Suharto family is one of the firm’s largest owners. The indicator is also 1 if the company is a state-owned
enterprise. Firm characteristics are measured at the end of fiscal year 1996. ‘‘Firm size’’ is the log of total assets in
millions of rupiah. ‘‘ROA’’ is the ratio of operating income to total assets. ‘‘Capital intensity’’ is the ratio of fixed
assets to total assets. ‘‘Financial leverage’’ is the ratio of long-term debt to total assets. ‘‘Industry’’ indicators are
included for agriculture, manufacturing, transport, trade, and finance. Standard errors (in parentheses) are
clustered based on group affiliations reported by Fisman (2001) and Claessens et al. (2000). Models 4, 5, and 6
drop firms that are affiliates or subsidiaries of foreign firms. We denote (two-sided) levels of statistical significance
as follows: y significant at 10%, * significant at 5%, ** significant at 1%.
At the bottom of the table, we report two types of tests: an F-test for the hypothesis that the coefficient on the
first-stage instrument is zero (H0: b^ 1 (Instrument) ¼ 0), and a Smith and Blundell (1986) test with the null
hypothesis that our closeness measures are exogenous.
(1) (2) (3) (4) (5) (6)
Closeness to Suharto 4.018 4.021 4.618 5.042

(1.654)* (1.640)* (1.752)** (1.742)**
Closeness to Suharto 1.920
(resignation returns) (0.938)*
Suharto-family owned or 0.940
State-owned enterprise (0.477)*
Firm size 0.852 0.837 0.806 0.793 0.635 0.829
(0.163)** (0.177)** (0.189)** (0.190)** (0.154)** (0.173)**
ROA 0.615 1.287 2.648 0.411 3.416
(2.750) (3.077) (3.793) (3.785) (3.991)
Capital intensity 0.959 0.435 0.640 1.034 0.691
(1.031) (0.925) (0.923) (0.915) (0.948)
Financial leverage 1.777 1.364 0.992 1.160
(0.941)y (0.911) (0.923) (0.934)
Industry indicators Included Included Included Included Included Included
Constant 18.986 19.063 18.749 18.250 15.060 19.241
(3.425)** (3.821)** (4.152)** (4.146)** (3.471)** (3.807)**
Observations 130 130 130 119 119 119
Pseudo R2 0.38 0.39 0.41 0.41 0.40 0.38
H0: b^ 1 (age) ¼ 0 0.009 0.003 0.015 0.120 0.095 N/A

(Prob4F) (Smith–Blundell test (0.500) (0.643) (0.868) (0.862) (0.965)
(Prob4w2))
H0: b^ 1 (Chinese) ¼ 0 0.037 0.048 0.018 0.011 0.107 N/A
(Prob4F) (Smith–Blundell test (0.455) (0.415) (0.502) (0.706) (0.518)
(Prob4w2))
H0: b^ 1 (Chinese+age) ¼ 0 0.015 0.021 0.010 0.010 0.125 N/A
(Smith–Blundell test (0.927) (0.848) (0.691) (0.688) (0.640)
(Prob4w2))
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we effectively assume that companies not owned by a member of the Suharto family are
not connected. This approach erroneously classifies non-family connections as non-
connections, thereby reducing differences between connected and unconnected firms and
biasing the estimated coefficient downward. This issue is less likely to arise with our return-
based proxy for political connections.
4.2. Are the results driven by susceptibility to bad news or differences in foreign exposure?
One concern with our results is that the return-based closeness measure could pick up
unobserved cross-sectional variation that is unrelated to firms’ political connections. One
possibility is that closeness captures how strongly a firm reacts to negative market news,
irrespective of whether these news items concern President Suharto or other economic
events. Another issue might be that health-based returns reflect firms’ differential exposure
to domestic and foreign product markets. Days on which health problems of Indonesia’s
leader are reported could simply be bad days for the Indonesian economy as a whole,
which have a disproportionately larger negative effect on firms with a strong domestic
orientation. We address these concerns by controlling for a firm’s susceptibility to bad
news and its exposure to foreign markets.
First, we compute the standard deviation of weekly returns in 1996 and add this measure
of historical volatility to the probit model. Firms with more volatile stocks are likely to
react more strongly to any news event. Table 3 reports this model in the first column. The
coefficient on volatility is positive but not significant (p-value ¼ 0.168). More importantly,
closeness to Suharto continues to be highly significant and negatively associated with
foreign securities.
Second, we compute cumulative returns over alternative event days with extreme
negative market news. To obtain events that are unrelated to the Suharto regime, we
identify the worst five non-adjacent trading days for the Hang Seng Index (Hong Kong) as
well as for the Strait Times Index (Singapore) between January 1995 and April 1997.6 This
is the same time period over which the health events occurred. We construct three
alternative proxies that capture how strongly a firm’s stock reacts to bad news. For each
sample firm, we compute its cumulative return over (a) the Hong Kong events, (b) the
Singapore events, and (c) the days that register as the worst days in both Hong Kong and
Singapore. The latter days appear to be Asia-wide bad news. The average cumulative
returns for our sample firms are 3.8%, 7.4%, and 8.0%, respectively.
Table 3 reports probit models controlling for the returns during the Hong Kong and
Singapore events (Columns 2 and 3).7 The results using returns on the combined event
days are similar and not reported for brevity. In all cases, we find that the coefficient on
political closeness slightly increases in magnitude and significance. Thus, these tests
provide no evidence that differences in firms’ responsiveness to negative news in general
drive our main result.
6
Adjacent trading days are combined into one event. We make sure that the event windows do not overlap with
the Suharto health events. We also examine news reports for these days. The negative returns on these days
primarily reflect worldwide equity market movements or interest rate or dollar exchange rate changes.
7
There are two firms for which we cannot compute returns for the Singapore events because the worst days in
Singapore were in 1995 and early 1996 before these two firms started trading on the Jakarta exchange.
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Table 3
Foreign securities and political connections—robustness tests
The table reports probit estimates of the likelihood that the 130 Indonesian firms in our sample have publicly
traded foreign securities. The dependent variable takes on a value of one if the firm has foreign securities and zero
otherwise. ‘‘Volatility’’ is computed as the standard deviation of weekly returns in 1996. The ‘‘susceptibility to bad
news’’ is based on returns measured on extreme days with negative market news that are unrelated to the Suharto
regime. For each sample firm, we compute the cumulative return on the worst five non-adjacent trading days for
the Hang Seng Index (Hong Kong) and, separately, for the Strait Times Index (Singapore) between January 1995
and April 1997. Column 2 (3) reports the results using returns on the Hong Kong (Singapore) events. ‘‘Exposure’’
is based on currency shocks, i.e., changes in the rupiah–dollar exchange rate of more than one percent. In Column
4, we use the sum of the absolute returns over the three worst and three best days of the exchange rate. In Column
5, we compute cumulative returns over the five worst days, i.e., days when the rupiah fell against the dollar.
‘‘External financing needs’’ is the firm’s actual asset growth rate minus the maximum growth rate that can be
financed if a firm relies only on its internal resources and maintains its dividend, as suggested by Demirgüc-Kunt
and Maksimovic (2002).
The other control variables are as defined before (see Table 2 for details). We denote (two-sided) levels of
statistical significance as follows: y significant at 10%, * significant at 5%, ** significant at 1%.
(1) (2) (3) (4) (5) (6)
(Volatility) (HK (SG returns) (D Rupiah) (D (Ext. Fin.)

returns) Rupiah)
Closeness to Suharto 4.371 4.866 5.186 5.822 5.623 5.424

(1.624)** (1.806)** (1.842)** (1.895)** (2.219)** (1.851)**
Volatility 6.269
(4.751)
Susceptibility to bad news 0.810 2.756
(1.541) (1.839)
Exposure 3.390 6.114
(1.751)* (2.490)*
External financing needs 0.809
(0.341)*
Firm size 0.826 0.801 0.777 0.882 0.957 0.802
(0.183)** (0.189)** (0.191)** (0.202)** (0.212)** (0.196)**
ROA 1.623 1.351 1.723 1.940 2.016 2.559
(2.980) (2.992) (2.990) (3.102) (3.214) (3.372)
Capital intensity 0.376 0.466 0.543 0.011 0.165 0.433
(0.915) (0.932) (0.963) (0.929) (0.970) (0.979)
Financial leverage 1.692 1.747 1.892 1.557 2.066 2.017
(0.919)y (0.951)y (1.023)y (0.946)y (1.004)* (0.989)*
Industry Included Included Included Included Included Included
Constant 19.474 18.664 18.332 20.724 21.797 19.040
(4.031)** (4.136) (4.182)** (4.393)** (4.575)** (4.324)**
Observations 130 130 128 130 130 126
Pseudo R2 0.41 0.41 0.41 0.44 0.45 0.43
Next, we control for differences in firms’ exposure to foreign markets and the
Indonesian economy. We compute stock returns on days with currency shocks, i.e.,
extreme changes in the rupiah–dollar exchange rate. Returns on these days are
likely to reflect cross-sectional differences in the degree to which firms are exposed to
foreign and domestic product markets. We accumulate returns in two ways. First, to
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capture positive and negative rate fluctuations, we sum the absolute returns on the
three ‘‘worst’’ and three ‘‘best’’ days of the rupiah–dollar exchange rate in the time
period during which the health events occurred. Second, we compute cumulative
returns over the five days during which the rupiah weakened most significantly against
the dollar. On all these days, the rupiah–dollar exchange rate changed by more than
one percent.
Table 3 reports probit estimates using both exposure measures as additional controls
(Columns 4 and 5). In both cases, the coefficient on exposure is significant and positive.
That is, firms that are more affected by changes in the rupiah–dollar exchange rate are
more likely to have foreign securities. The positive coefficient on returns for days on
which the rupiah fell against the dollar suggests that firms with foreign securities
generally benefit from a weak rupiah, perhaps because they are more export-oriented
and more engaged in foreign markets. This finding is interesting in light of the recent
debate about the performance effects of debt denominated in foreign currency. The
macroeconomic literature on financial crises distinguishes two effects of currency
devaluations: a drop in ‘‘net worth,’’ which weakens firms’ balance sheet positions, and
a competitiveness effect which improves financial performance (Krugman, 1999; Aghion
et al., 2001). As in Bleakley and Cowan (2002), our results seem to imply that the
competitiveness effect dominates the ‘‘net worth’’ effect. In models 4 and 5 (Table 3),
controlling for the exposure to foreign markets slightly increases the negative relation
between closeness to Suharto and the likelihood of having foreign securities. We also check
that controlling simultaneously for historical volatility, susceptibility to bad news, and
exposure produces similar results to those reported in Table 3. But even then, the closeness
measure remains highly significant.
A final concern is that firms with foreign securities are financially less dependent on
Suharto and hence less likely to experience negative returns on days with bad news
about Suharto’s health. This logic suggests that the negative association between our
return-based closeness measure and foreign financing might reflect financial dependence
on Suharto. Our models control for leverage, capital intensity, and industry, all of
which are likely to be associated with firms’ external financing needs, thus alleviating the
concern to some extent. To directly address this issue, we compute a proxy for a firm’s
dependence on external capital suggested by Demirgüc-Kunt and Maksimovic (2002).
If connected firms with higher external financing needs are more financially dependent on
Suharto, introducing a proxy for these needs will attenuate the measured effect of
closeness. As expected, we find that firms with larger external financing needs are
more likely to have foreign securities (Table 3, model 6). However, the coefficient on
closeness remains negatively associated with foreign securities and even increases
relative to Table 2. In addition, our family-based connection measure, which is not
subject to this final concern, produces similar results. Thus, our result that political
connections and foreign financing are substitutes does not seem to be driven by financial
dependence on Suharto.
4.3. Is closeness to Suharto endogenously determined?
While a firm’s exposure to foreign markets and its susceptibility to bad news do not
explain the relation between political connections and global financing, there is, more
generally, a concern that the closeness measure could be endogenously determined. The
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models in Table 2 assume that firms’ political connections are predetermined. This
assumption is not unreasonable because many important political connections in
Indonesia appear to be family related (see model 6 in Table 2 and Backman, 2001).
Similarly, for Malaysia, another country with a centralized political power structure,
Johnson and Mitton (2003) argue that political connections are based on chance and have
long personal histories. Nevertheless, we develop an instrumental-variable strategy to
address the endogeneity concern.
Smith and Blundell (1986) suggest a simple exogeneity test for models with limited
dependent variables. The test involves the estimation of a first stage with closeness as the
dependent variable. The residuals from the first stage are then included as an additional
covariate in the models in Table 2. Under the null hypothesis of exogeneity, the first-stage
residuals have no explanatory power at the second stage. The standard order condition
for identification applies, so we need at least one instrument for a firm’s closeness to
the regime.
We focus on two instruments that have the advantage of not being choice variables. The
first instrument is the firm’s age. Controlling for closeness, age has no independent effect
on the firm’s likelihood of having foreign securities, but younger firms are more likely to
have close political connections, possibly because they are in greater need of ‘‘political
help’’ early in their lives when they establish themselves in the fairly concentrated
Indonesian business environment.8 Our second instrument is the ethnicity of a firm’s
president director.9 Given the delicate state of race relations in Indonesia, it is likely that
Chinese managers viewed close political connections with former President Suharto in a
different light than indigenous Indonesians (Pribumis). In Indonesia, political favors of
questionable legality typically needed to be repaid by kickbacks and side payments of an
equally dubious nature. This practice was risky for any manager, but particularly perilous
for Chinese executives because their ethnicity could be used against them. The trial of
Golden Key owner Tan Tjoe Hong provides an example. Accused of having fraudulently
secured a $430 million letter of credit, Hong was subject to a vocal anti-Chinese campaign
throughout his trial. The Far Eastern Economic Review reports that Indonesians holding
anti-Chinese views were paid to attend the court hearings (McBeth, 1994). Perhaps due to
such fears and pressures, Chinese managers in our dataset are on average not as close to
the Suharto regime as Pribumis.
To be valid instruments, firm age and the ethnicity of the president director must
be correlated with political closeness but uncorrelated with the choice of foreign
securities. Consistent with this requirement, we do not find evidence that firm age
or the ethnicity of the president director influence firms’ choices of foreign securities
other than through the channel of political connections. Whether included separately or
jointly in the models of Table 2, the coefficients on the instruments remain economically
8
We thank Benny Tabalujan for suggesting this instrument and providing anecdotal evidence.
9
Indonesian firms have a two-tiered board structure. The president director heads the managing board of
directors. Hence, the role of the president director broadly corresponds to the role of the CEO. Information on the
ethnicity of the president director and the dominant owner, which we use as an alternative instrument, comes from
a large number of publicly available sources such as press reports and company websites. We crosschecked
information with an Indonesian accounting firm, an Indonesian stockbroker, and Indonesian students at the
Wharton School. Michael Backman also kindly shared his expertise in these matters. A complete list of all sources
is available upon request.
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small and statistically insignificant, whereas the closeness variable remains largely
unchanged.10
At the first stage, firm age and the president director’s ethnicity are significant predictors
of our closeness measure (see F-tests for the null that the coefficients on the instruments are
zero, reported at the bottom of Table 2.) Our instruments are weaker when we use
resignation returns as the measure for political connections. Table 2 also reports p-values
for the Smith–Blundell exogeneity test. As shown, we cannot reject exogeneity using either
firm age, the ethnicity of the president director, or both instruments. In all cases, the
p-values are far from conventional significance levels. Assuming that either firm age or the
president director’s ethnicity are valid instruments, we find no evidence that our closeness
measure is endogenous to the choice of foreign securities.
Overall, the results presented in Tables 2 and 3 lend reasonable support to our
hypothesis that domestic opportunities influence firms’ foreign financing choices. All three
measures of political connections—stock returns during Suharto’s health crises, stock
returns during Suharto’s resignation, and a direct family-based measure—indicate that
firms with good political connections are less likely to have publicly traded foreign
securities.
5. Public and private foreign securities
In this section, we investigate whether our results are specific to the type of foreign
securities we have analyzed so far. We explore this question in two ways. First, we apply a
narrower definition of foreign security using only a subset of issues that are publicly traded
on major U.S. exchanges. These securities require a 20-F filing with the SEC and hence
come with more stringent disclosure requirements. Second, we analyze foreign securities
that are private debt agreements or private equity placements. These arrangements allow
investors to be informed via private channels rather than public disclosure. Contrasting the
results for private and public foreign securities can shed some light on the role that
informational considerations play in firms’ foreign financing decisions.
We identify eight firms with U.S. debt or equity securities that require a 20-F filing with
the SEC. Table 4 reports the probit estimates using the full set of controls (Column 1).
Firms that are closer to Suharto are significantly less likely to have U.S. securities that
require a 20-F filing. The result is essentially the same as the one for our broader
classification. To determine whether the earlier estimates for the more inclusive
classification are solely driven by securities that are publicly traded in the U.S., we re-
estimate the model in Table 2 excluding 20-F firms (Column 2).11 Closeness to Suharto is
still a significant predictor of global financing choices. We also check whether the
distinction between debt and equity securities is relevant to our analysis. We re-estimate
our models using either foreign debt or foreign equity securities only. In these analyses,
closeness to Suharto is negatively associated with both types of foreign securities. For this
reason, we do not think that our findings have capital structure implications.12
10
When included in specification (3) of Table 2, the coefficient on age is 0.002 with a standard error of 0.013.
The coefficient on ethnicity is 0.285 with a standard error 0.490.
11
Eliminating 20-F firms still leaves one firm in the sample that trades in the U.S. but does not file with the SEC.
Dropping this firm does not alter the results reported in Column 2 of Table 4.
12
Our analysis focuses on the question where firms obtain finance and not whether it is debt or equity. Capital
structure theories should therefore apply in the usual way.
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Table 4
U.S. securities with 20-F filing, private foreign securities, and political connections
The table reports probit estimates of the likelihood that the 130 Indonesian firms in our sample have a certain
type of foreign security. In the first column, the dependent variable takes on a value of one if the firm has securities
that are publicly traded in the U.S. and require a 20-F filing with the SEC, and 0 otherwise. In model (2), firms
with publicly traded foreign securities that do not require a 20-F filing are analyzed. In Column 3, the binary
dependent variable indicates with a value of one that the firm has private securities (e.g., loans or private equity
placements) that were arranged by at least one foreign investment bank as a lead manager. In Column 4, the
dependent variable is based on information about the security’s (target) marketplace indicated in the SDC
database. If the security is privately placed outside of Asia or specifically classified as a ‘‘foreign private
placement,’’ we set the binary variable equal to one. In the fifth column, the dependent variable takes on a value of
one if the firm has private placements in the U.S. All private securities are classified based on information in the
SDC database.
All other variables are as defined before (see Table 2 for details). We denote (two-sided) levels of statistical
significance as follows: y significant at 10% * significant at 5% ** significant at 1%.
(1) (2) (3) (4) (5)
Public U.S. Foreign Private Private Private U.S.

securities (20-F securities w/o securities securities securities
filing) 20-F (Foreign (Foreign (144a
bank) market) placement)
Closeness to Suharto 6.791 3.713 0.259 0.578 1.341

(2.734)* (1.797)* (1.345) (1.779) (1.213)
Firm size 0.590 0.699 0.442 0.691 0.336
(0.168)** (0.197)** (0.104)** (0.110)** (0.097)**
ROA 2.070 1.356 0.327 0.785 2.765
(4.203) (3.216) (1.900) (3.101) (2.957)
(1.036)** (1.047) (0.661) (0.595) (0.526)
Financial leverage 2.439 1.581 1.610 0.125 1.047
(1.393)y (0.933)y (0.856)y (0.954) (0.837)
Industry Included Included Included Included Included
Constant 16.213 16.448 8.726 15.524 9.340
(4.128)** (4.275)** (2.179)** (2.279)** (2.000)**
Observations 130 122 130 130 130

Pseudo R2 0.47 0.33 0.23 0.34 0.15
Next, we analyze if firms that were close to the Suharto regime are also less likely to have
private foreign securities such as loans from foreign banks and private placements in the
U.S. under Rule 144a. We obtain data from the SDC database on private securities such as
term loans, revolving credit facilities, syndicated loans, and private equity placements. As
private securities are not traded, it is more difficult to determine what precisely constitutes
a foreign security. We create three variables. The first indicates that at least one of the lead
managers arranging the private security is a foreign investment bank. We identify 64
private securities of this type. The second variable is based on the ‘‘market place’’ indicated
in SDC, i.e., the region that a private placement targets (e.g., Asia, Europe, or the U.S.).
Our indicator equals one if the firm’s securities are privately placed outside Asia or if the
placement is specifically classified as ‘‘foreign.’’ We identify 23 securities of this type.
Finally, the third variable is even more specific indicating private placements in the U.S.
There are eight such securities.
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Table 4 reports probit estimates for the three definitions of private securities. All
specifications include the full set of controls (Columns 3–5). While the standard errors are
similar in magnitude to the errors in our previous analyses, the coefficients on the private
securities indicators are insignificant in all cases. Firms that were close to Suharto are as
likely as firms without political ties to have private foreign securities. The contrast between
the findings for the U.S. securities requiring 20-F filings (Column 1) and U.S. private
placements (Column 5) is particularly interesting because the comparison holds the foreign
target market constant. To confirm that the coefficients on closeness are in fact statistically
different across the models for public and private foreign securities, we estimated a series
of bivariate probit models (not tabulated). Relative to their probability of having publicly
traded securities, politically connected firms are significantly more likely to have private
securities. The differences documented in Table 4 are not the result of weak statistical
power.
The results in this section indicate that it matters whether a foreign security is publicly
traded or privately issued, suggesting that transparency considerations do play some role
in the documented tradeoff between political connections and foreign financing. While the
evidence in Table 4 points to one possible interpretation of our findings, we acknowledge
that the evidence is merely suggestive. The mechanism question is not central to this paper,
and we leave it to future work to determine why closely connected firms are reluctant to
issue publicly traded foreign securities.
6. Returns to foreign securities before and during the Asian financial crisis
Another approach to testing our hypothesis that political relationships and foreign
securities are alternative means of increasing firm value is to explicitly study the
performance consequences of the two strategies. This analysis also demonstrates how
important it is for empirical studies to account for the endogeneity of listing decisions.
We analyze the stock returns of our sample firms one year prior to and during the
financial crisis of 1997 and 1998. In a financial market equilibrium, it would be surprising if
firms with foreign securities consistently outperformed firms with strong political
relationships. In contrast, unexpected shocks such as the financial crisis in Asia are more
likely to result in significant differences in performance. The Asian crisis, which many
believe was due in part to weak corporate governance and low levels of transparency
(Stiglitz, 1998; Harvey and Roper, 1999), might have created a premium for more
transparent firms. Johnson et al. (2000), Mitton (2002), Lemmon and Lins (2003), and
Baek et al. (2004) provide evidence to this effect.
However, as the results in the previous section suggest, global financing and corporate
transparency are only half the story. In measuring the performance effects of foreign
securities, it is important to take into account firms’ political connections and consider
how the regime responded to the economic turmoil. If President Suharto lost some of his
ability to support politically well-connected firms during the crisis, return regressions that
ignore political connections overestimate the value of foreign listings. In contrast, if
Suharto supported ‘‘his’’ firms during the crisis, the benefits of foreign securities during the
crisis might be larger than previously estimated. There is ample evidence that Suharto was
personally involved in propping up connected companies during the 1997–1998 turmoil.
For instance, Texmaco, a large Indonesian conglomerate with excellent connections,
received loans in excess of $1 billion from Bank Negara Indonesia (BNI) during the crisis.
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Suharto personally authorized these loans that violated Indonesian lending caps (Tesoro,
1999; see also Solomon, 1999).13
To investigate the importance of having foreign securities, we estimate a series of models
explaining the stock price performance of our sample firms prior to and during the Asian
financial crisis. In particular, we compare models that treat the presence of foreign
securities as exogenous with models that explicitly take into account that foreign securities
are chosen with a view to prior political investments. We investigate the year prior to the
crisis (7/1/96–6/30/97) and the crisis period itself (6/30/97–8/31/98). The latter study period
is chosen to make our results directly comparable to the analysis in Mitton (2002). We use
annualized log returns ri as our dependent variable so that we can compare the magnitude
of the estimated coefficients across time periods. We control for firm size (measured as the
log of total assets), financial leverage (ratio of long-term debt to total assets), and the
historical volatility of the stock (standard deviation of weekly returns in 1996):
ri ¼ X i b þ fyi þ ms þ ei . (3)
The results in Mitton suggest that firms with foreign securities outperform other firms
during the crisis, i.e., f40: The performance effects of foreign financing are reported in
Table 5. In a simple OLS regression, we find a positive and significant effect during the
crisis (Column 4), consistent with Mitton. In contrast, firms with foreign securities do not
outperform other firms in the year prior to the crisis (Column 1), which is in line with our
expectations for returns in a financial market equilibrium. To the extent that these
estimates are biased, the bias is not the result of an omitted variable problem. Adding our
measure of closeness to these regressions, political connections bear no significant relation
to stock returns and the coefficient on foreign securities changes little.
Next, we estimate treatment effects models. These models explicitly account for the
substitutive relation between political connections and global financing, thereby isolating
the marginal effect of foreign securities on performance. The first stage of these models is
the corresponding probit model from Table 2. At the second stage, we estimate Eq. (3).
For all models, we clearly reject independence of the two stages (see the Wald tests
reported at the bottom of the table). Thus, it is inappropriate to run simple performance
regressions to measure the impact of foreign securities on stock returns.
The first set of treatment effects results are presented in Columns 2 and 5 of Table 5. The
performance effects of foreign securities are considerably larger than in the simple OLS
regressions. Conceptually, the difference is an estimate of the benefits that Suharto
provided to well-connected firms during the crisis. Controlling for political relationships,
we now find a positive performance effect of foreign securities for the year prior to the
Asian crisis, underscoring that both political connections and foreign securities contribute
to firm value even outside the crisis.
To address the concern that our results simply reflect long-run differences in
performance across firms, a second set of treatment effects models controls for firm
profitability prior to the crisis (ROA) and firms’ financing needs (capital intensity) (see
Columns 3 and 6, Table 5). These controls reduce the magnitude of the estimated
performance effects only minimally.
13
Connected families can also prop up their ailing conglomerate using private funds, but such behavior while
interesting is a separate issue (see Tabalujan, 2002; Friedman et al., 2003; Cheung et al., 2004).
ARTICLE IN PRESS
Table 5
Returns to foreign securities
The table reports regression results with annualized log returns for 130 Indonesian firms as the dependent
variable. ‘‘Foreign Securities’’ is an indicator equal to 1 if a firm has publicly traded foreign securities and 0
otherwise. Firm characteristics are measured at the end of fiscal year 1996. ‘‘Firm size’’ is computed as the log of
total assets. ‘‘Financial leverage’’ is the ratio of long-term debt to total assets. ‘‘Volatility’’ is the standard
deviation of the weekly stock returns during 1996. ‘‘ROA’’ is the ratio of operating income to total assets.
‘‘Capital intensity’’ is the ratio of fixed assets to total assets. ‘‘Industry’’ indicators are included for agriculture,
mining, manufacturing, transport, trade, finance, and services. Standard errors (in parentheses) are clustered
based on group affiliations reported by Fisman (2001) and Claessens et al. (2000).
In the two-stage treatment effects models, the first stage is a probit model (Models 2 and 3 in Table 2,
respectively). We report the result of a Wald test for the null hypothesis that the first-stage and the second-stage
equations are independent (r ¼ 0). At the bottom of the table, we test whether the effect of foreign securities on
returns is different before and during the crisis (fpre-crisis ¼ fcrisis) using pooled models. The standard errors for
the pooled models are bootstrapped using 1,000 replications. The coefficient on the interaction in Column 4
compares the estimated performance effects of foreign securities in Row 1 of Columns 1 and 4 (and analogously
for Columns 5 and 6).
We denote (two-sided) levels of statistical significance as follows: y significant at 10%, * significant at 5%, **
significant at 1%.
7/1/96–6/30/97 Pre-crisis 7/1/97–8/31/98 Mitton (2002)
(1) (2) (3) (4) (5) (6)
OLS 2-stage 2-stage OLS 2-stage 2-stage

estimates estimates estimates estimates
Foreign securities 0.029 0.452 0.440 0.682 2.350 2.211

(0.100) (0.202)* (0.205)* (0.271)* (0.470)** (0.203)**
Firm size 0.034 0.104 0.094 0.079 0.342 0.290
(0.028) (0.037)** (0.037)** (0.104) (0.122)** (0.103)**
Financial leverage 0.291 0.271 0.354 1.293 0.697 1.720
(0.284) (0.263) (0.291) (0.659)y (0.808) (0.691)*
Volatility 2.473 1.711 1.607 1.446 0.559 0.943
(1.479)y (1.586) (1.585) (3.430) (2.446) (1.968)
ROA 0.517 2.295
(0.448) (1.410)y
Capital intensity 0.197 0.820
(0.169) (0.501)y
Industry Included Included Included Included Included Included
Constant 0.608 2.095 2.008 2.029 4.382 3.112
(0.593) (0.778)** (0.773)** (2.190) (2.290)y (2.066)
Observations 130 130 130 130 130 130

R-squared 0.21 0.22
H0: r ¼ 0 ðProb4w2 Þ 0.0059 0.0060 0.0085 0.0000
H0: fpre-crisis ¼ fcrisis 0.507 0.415 0.420

Foreign Sec. crisis (0.336) (0.269) (0.279)
Foreign securities 0.119 0.971 0.942
(0.154) (0.420)* (0.427)*
Crisis 1.706 1.691 1.691
(0.135)** (0.114)** (0.118)**
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Finally, it is interesting to know whether the benefits of having foreign securities

increased during the Asian financial crisis. A casual glance at Table 5 suggests that the
performance effects of foreign securities are larger during the crisis. To formally test this
hypothesis, we pool pre-crisis and crisis returns to form a panel. We control for the period
by introducing a time indicator (Crisis) that equals 1 for returns during the crisis. An
interaction term Foreign Securities Crisis allows the performance effect of foreign
securities to vary by period. While we include all other covariates shown in the upper half
of Table 5, we only report the coefficient estimates for foreign securities, the crisis, and the
interaction term at the bottom of Columns 4, 5, and 6. Bootstrapped standard errors based
on 1,000 replications are given in parentheses. As expected, returns are significantly lower
during the crisis. Moreover, the coefficients on the interaction term are positive in all three
models. However, they are not statistically significant at conventional levels. Thus, there is
at best weak evidence that the Asian crisis increased the benefits of having publicly traded
foreign securities. As we have panel data, we can also estimate these models using firm
fixed effects. The resulting coefficient on the interaction remains virtually unchanged,
indicating that time-invariant unobserved firm characteristics do not bias our estimates.
Overall, the results presented in Table 5 suggest that President Suharto lent considerable
financial support to politically well-connected firms before and during the financial crisis.
As a consequence, conventionally measured performance effects of cross-listings or other
forms of foreign financing are considerably downward biased if political relationships are
ignored.
7. Dynamics of political relationships and foreign financing
Politically well-connected firms pursue different financing strategies than less connected
companies, and these strategies help explain some of the variation in performance during
the Asian financial crisis. In this section, we look beyond the immediate crisis to document
how politically connected firms fare over longer periods of time. We are particularly
interested in the performance of connected firms after their patrons leave office. Do
investments in political relationships continue to pay off even when a new government is in
charge? Indonesia provides an ideal context to study this question. After Suharto was
forced to step down on 21 May 1998, B.J. Habibie, a long-time Suharto ally, was
immediately sworn in as Indonesia’s new president. Habibie had personally benefited from
Suharto’s patronage and was widely expected to continue the Suharto policies.14 The
transition from Suharto to Habibie thus affords the opportunity to study the performance
consequences of political relationships when a friendly government succeeds a regime.
In contrast, President Abdurrahman Wahid, who was elected on October 21, 1999, ran
on an anti-establishment platform and was much more critical of the Suharto regime.
14
While small in comparison to the Suharto empire, which Time Magazine estimated to be $73 billion prior to
the financial crisis and $15 billion in 1998 (Colmey and Liebhold, 1999), the Habibie family controlled interests in
chemicals, construction, real estate, transport, and communications. Many of these businesses had profited from
government contracts and state-granted monopolies (Symonds, 1998). The BBC concluded that ‘‘President
Habibie owes his rise to power entirely to his close friendship with former President Suharto’’ (Head, 1998).
Suharto met Habibie in the 1950s when he was stationed on the island of Sulawesi. In 1974, Suharto asked
Habibie, who was then working in Germany, to return to Indonesia and placed him in charge of the state-owned
oil company. In 1978, Habibie was appointed Minister of Research and Technology, a post he held until he was
endorsed as vice-president (Symonds, 1998).
ARTICLE IN PRESS
However, even if the opposition takes over, it is not obvious that firms connected to the old
regime will perform worse. First, some of the benefits associated with political connections
are not easy to revoke in a legal manner, such as banking and mineral extraction licenses as
well as long-term loans from state-owned banks. Second, companies that decided to invest
in close links with the old regime might also find it beneficial to build close relations with
the new government. Ultimately, it is the nature of political relationships that critically
influences how connected firms perform when the regime changes. In models of political
economy, political favors are often traded like other resources: politicians with influence
offer more of their services to firms that offer higher payments (Bernheim and Whinston,
1986; Grossman and Helpman, 1994; Persson, 1998). In these models the same groups will
be influential independent of the government that is in office. However, in richer models of
the policy process, such as in specifications with partisan preferences (Alesina, 1988),
politicians are no longer perfect substitutes, interest groups might favor particular
candidates, and these candidates will have incentives to repay ‘‘their’’ groups when they are
in power (for surveys, see Austen-Smith, 1997; Rodrik, 1995). The price of buying political
favors is then path-dependent: supporting a particular regime in one period influences the
future cost of favors. The study of the performance consequences of regime changes thus
implicitly tests the plasticity of political relationships. An interesting null is that regime
changes do not matter because firms can invest in new regimes just as easily as they were
able to build connections with the old guard.
To study the performance consequences of regime changes, we collected firm-
level performance data and controls for four periods: Suharto prior to the financial
crisis (7/1/96–6/30/97), Suharto during the crisis (7/1/97–5/21/98), the Habibie period
(5/22/98–10/19/99), and the Wahid government (10/21/99–6/30/01). We estimate models
of the form
rit ¼ X it b þ gC i þ lC i Rt þ yRt þ eit , (4)
where the rit are annualized log returns in period t, Xit is a vector of firm characteristics, Ci
denotes the closeness to the Suharto regime, and Rit is an indicator variable for a particular
Indonesian government. The omitted time period is the Suharto regime before the crisis.
The specification is a difference-in-difference model. The coefficient of interest, l, measures
how the difference in annualized returns that is due to connections changes with changes in
the regime.
A potential concern with estimates from (4) is that politically well-connected firms
differ in unobserved ways from less-connected companies and that these differences
are correlated with financial performance. We can difference out such time-invariant
heterogeneity by estimating
rit ¼ X it b þ lC i Rt þ yRt þ ni þ eit , (4a)
where ni is a firm fixed effect. Note that ni subsumes the main effect of closeness on stock
performance.
The results for model (4) are reported in Table 6. There is clear evidence of path
dependence. Compared to the pre-crisis period, firms with close connections to Suharto
fared worse during the crisis when Suharto was in power and during the Wahid
government. Under Habibie, connected firms performed as well as they did prior to the
crisis. Model 4 of Table 6, where we include all three regimes, confirms that, relative to
the pre-crisis period, the Habibie government was the only period during which
ARTICLE IN PRESS
Table 6
Returns to political connections under different governments
The table reports regression results with annualized log returns for 130 Indonesian firms as the dependent
variable. ‘‘Closeness to Suharto’’ is the log stock return over six news events indicating that President Suharto is
in bad health, multiplied by –1. There are three indicators for different periods. ‘‘Suharto Crisis’’ is the period
from 7/1/97 to 5/21/98. Habibie is an indicator for the time period during which President Habibie was in power,
5/22/98–10/19/99. Another indicator denotes the government of President Wahid, 10/21/99–6/30/01. The omitted
period is 7/1/96–6/30/97, a pre-crisis period during which President Suharto ruled Indonesia. ‘‘Firm size’’ is
computed as the log of total assets. ‘‘Financial leverage’’ is the ratio of long-term debt to total assets. ‘‘Volatility’’
is the standard deviation of the weekly stock returns. ‘‘Industry’’ indicators are included for agriculture, mining,
manufacturing, transport, trade, finance, and services. Model (5) includes firm fixed effects. Standard errors (in
parentheses) are clustered based on group affiliations reported by Fisman (2001) and Claessens et al. (2000). At
the bottom of the table, we report p-values from F-tests of the null hypothesis that the sum of the ‘‘Closeness to
Suharto’’ variable and its interaction with a particular time indicator is zero. We denote (two-sided) levels of
statistical significance as follows: y significant at 10%, * significant at 5%, ** significant at 1%.
Pre-crisis vs. Pre-crisis vs. Pre-crisis vs. All periods

Suharto crisis Habibie Wahid
7/1/96–6/30/97 & 7/1/96–6/30/97 & 7/1/96–6/30/97 & 7/1/96–6/30/2001

7/1/97–5/21/98 5/22/98–10/19/99 10/21/99–6/30/01 & 7/1/96–6/30/97
(omitted)
(1) (2) (3) (4) (5) Firm-fixed

effects
Closeness to Suharto 0.952 0.654 0.956 0.809

(0.530) (0.570) (0.550) (0.578)
Closeness Suharto 2.278 2.241 2.258
crisis (0.774)** (0.855)** (0.949)*
Closeness Habibie 0.315 0.248 0.093
(0.766) (0.843) (0.930)
Closeness Wahid 1.809 2.063 2.226
(0.762)* (0.866)* (0.965)*
Suharto crisis 0.766 0.905 0.921
(0.102)** (0.108)** (0.128)**
Habibie 0.057 0.184 0.080
(0.112) (0.119) (0.152)
Wahid 0.473 0.666 0.716
(0.109)** (0.116)** (0.145)**
Firm size 0.046 0.066 0.117 0.076 0.090
(0.031) (0.028)* (0.028)** (0.022)** (0.116)
Financial 0.330 0.222 0.278 0.081 0.198
leverage (0.265) (0.144) (0.168) (0.128) (0.209)
Volatility 4.169 4.433 1.402 0.834 2.310
(1.477)** (0.782)** (0.902) (0.677) (0.960)*
ROA 1.358 0.513 1.293 0.480 0.268
(0.583)* (0.204)* (0.373)** (0.201)* (0.278)
(0.217) (0.186) (0.181) (0.157) (0.363)
Industry Included Included Included Included –
Constant 1.648 0.908 2.320 1.792 1.899
(0.734)* (0.630) (0.653)** (0.524)** (2.364)
Observations 251 233 225 488 488

R-squared 0.50 0.25 0.48 0.43 0.44
p-values for H0: 0.0256 0.5274 0.1170 0.0265
close+close 0.0925
period ¼ 0 0.0574
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Suharto-connected firms did as well as before the crisis. Controlling for unobserved time-
invariant firm characteristics as in (4a), we find the same pattern of results as in our
previous models (model 5).
Were political connections a good long-term investment in Indonesia? The bottom row
of Table 6 reports p-values from F-tests of the null hypothesis that connections had no
influence on financial performance (g+l ¼ 0). We find that connected firms under-
performed during the crisis when Suharto was still in power, but they outperformed less
connected firms during the Habibie period. Once Wahid came to office, however, it was
not easy for the Suharto cronies to re-establish profitable political ties and the performance
of their companies suffered correspondingly. Anecdotal evidence is consistent with the
patterns in the data. For example, Texmaco’s chairman, Marimutu Sinivasan, who had
received huge loans during the Suharto period, maintained close connections with Habibie.
He was named Special Business Envoy for Asia, became vice treasurer for the ruling party,
and received lucrative orders from the Indonesian army. Wahid, in contrast, ordered an
investigation of Texmaco’s finances and insisted the case be settled ‘‘under the due process
of law’’ (Tesoro, 1999).
Having lost their political support, did the Suharto cronies find it more attractive to
issue foreign securities? Such behavior would be consistent with our results in Table 2. We
begin analyzing this conjecture by counting the firms with foreign securities under Suharto
and under Wahid. In Table 7 (upper panel), we document that there is considerable
variation over time. Of the 21 companies that had publicly traded securities in 1997, five
gave up their securities, and 12 companies added foreign securities to their financing
strategy. The middle panel in Table 7 looks at changes in financing for closely connected
and less-connected firms. A firm is classified as being close to Suharto if its closeness index
exceeds the median value of the sample. Nine closely connected but only three other firms
issued new foreign securities under the Wahid government. This is our first evidence that
Suharto firms responded to the change in government by adopting a more outward-
oriented financing strategy.
In the bottom panel of Table 7, we investigate the link between past political connections
and current financing strategies more formally. The first specification is a probit model that
is estimated on the sample of firms that did not have foreign securities during the Suharto
period and were still active in 2001 ðN ¼ 101Þ. The dependent variable takes on a value of
one if a company has publicly traded foreign securities in 2001 and zero otherwise.
Controlling for firm-specific characteristics, we find that firms that were closer to Suharto
have a greater tendency to issue foreign securities under Wahid. A one-standard-deviation
increase in closeness raises the likelihood of having new securities by 2.1 percentage points,
an effect that is statistically significant at the 6% level.
The second model in Table 7 reports results for all firms that are included in the original
sample and are still active in 2001 ðN ¼ 122Þ. This model uses information on firms that
adopt new securities and information on firms that give up foreign securities during the
Wahid government. The dependent variable is ordered. Adopting new foreign securities
increases exposure to foreign investors and giving up securities has the opposite effect.
Thus, we estimate an ordered probit model. The dependent variable is 1 if the firm no
longer has a foreign security, 0 if there is no change, and 1 if the company issued a new
security. We find that firms that were close to Suharto are more likely to adopt an
outward-oriented financing strategy under Wahid. Similar to our previous result, the
estimated coefficient on the closeness variable implies that a one-standard-deviation
ARTICLE IN PRESS
Table 7
New issues of foreign securities after regime changes
The first panel shows the number of firms with foreign securities in 1997 under Suharto and in 2001 under
Wahid. In the second panel, we report changes in securities for closely connected and less connected firms,
respectively. A firm is considered close to Suharto if its ‘‘Closeness Index’’ exceeds the median value for our
sample. The bottom panel reports two specifications. The first is a probit model for the 101 firms that did not have
foreign securities in 1997. The dependent variable takes on a value of 1 if the firm had a publicly traded foreign
security in 2001 and zero otherwise. ‘‘Closeness to Suharto’’ is the log stock return over six news events indicating
that President Suharto is in bad health, multiplied by –1. ‘‘Firm size’’ is the log of total assets in millions of rupiah.
‘‘ROA’’ is the ratio of operating income to total assets. ‘‘Capital intensity’’ is the ratio of fixed assets to total
assets. ‘‘Financial leverage’’ is the ratio of long-term debt to total assets. ‘‘Industry’’ indicators are included for
agriculture, manufacturing, trade, and finance. Standard errors (in parentheses) are clustered based on group
affiliations reported by Fisman (2001) and Claessens et al. (2000). The second specification is an ordered probit
model. The dependent variable is 1 (firm no longer has a foreign security), 0 (no change in foreign security), or 1
(issued new security), respectively. The sample consists of all firms from our original sample that survived. The
covariates are as described above. We denote (two-sided) levels of statistical significance as follows: y significant at
10%, * significant at 5%, ** significant at 1%.
Securities under Suharto and Wahid
Firms with foreign securities in Firms without foreign securities in

2001 2001
Firms with foreign securities in 16 5
1997
Firms without foreign securities in 12 89
1997
Changes in securities, by strength of connections
Firms close to Suharto Other Firms

Issued new foreign security 9 3
No change 50 55
Gave up foreign security 2 3
Securities and closeness
Foreign securities in 2001 (but not Changes in new securities

in 1997)
Closeness to Suharto 3.299 1.950
(1.756)y (0.825)*
Firm size 0.726 0.170
(0.250)** (0.103)y
ROA 5.070 1.271
(3.522) (2.173)
Capital intensity 0.466 0.221)
(0.734) (0.774
Financial leverage 2.698 2.420
(1.426)y (0.959)**
Industry Included Included
Constant 17.128
(5.660)**
Observations 101 122

Pseudo R2 0.432 0.139
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increase in closeness increases the likelihood of having new foreign securities by 2.5
percentage points. This effect is statistically significant at the 1.8% level.
The results in Tables 6 and 7 provide support for the view that political regime changes
have significant consequences for the performance of companies that invested in political
relationships and for the strategies that these companies adopt once a new government is
in power. They also corroborate our earlier findings on the link between global financing
and political connections.
8. Conclusions
In this study, we examine the role of political connections for firms’ financing strategies
and their long-run financial performance. We view political connections as an example of
domestic arrangements that reduce the benefits of global financing. Consistent with this
argument, our first set of results shows that well-connected firms are less likely to have
publicly traded debt or equity securities abroad, suggesting that connections and global
financing are substitutes. We also provide return-based evidence that firms derive
significant benefits from both foreign securities and political connections before and during
the Asian crisis. For this reason, it is important to consider domestic arrangements, such as
political connections, when estimating the performance benefits of global financing.
There are at least three explanations for our findings. First, well-connected firms have
access to preferential financing at home and therefore do not need to access foreign capital
markets. Second, firms with political ties dislike the transparency and scrutiny that come
with publicly traded securities. Third, foreign securities make it more difficult for insiders
to extract private control benefits. Although the exact mechanism is not central to our
study and conclusions, we make one attempt to shed some light on the question of whether
the transparency consequences of foreign securities play a role in our findings. We show
that Indonesian firms with close ties to the Suharto regime were as likely as non-connected
firms to have privately arranged foreign securities, which allow access to global capital
markets but do not come with the same outside scrutiny as publicly traded securities. Thus,
the distinction between private and public securities appears to matter. While this finding is
not a full explanation of why connected firms are less likely to have foreign securities, it is
consistent with the view that the informational consequences of publicly traded securities
play some role in the documented tradeoff between political connections and foreign
financing.
Our second set of results documents the financial consequences of regime changes for
firms with strong political ties to Suharto. We find that closely connected firms
underperformed during the Asian financial crisis as long as Suharto was in power,
recovered under Suharto’s long-time ally Habibie, but significantly underperformed under
Wahid, a cleric critical of the Suharto regime. This return pattern suggests that firms have
difficulty re-establishing connections with a new government when their patrons fall from
power. Given these difficulties, we document that Suharto firms are more likely to issue
publicly traded foreign securities after Wahid’s surprise election. This evidence further
supports the link between global financing and political connections.
Two broader conclusions emerge from our findings. First, the results shed light on the
difficulties of institutional reform and capital market liberalization in emerging market
economies like Indonesia. Well-connected firms do not find global financing very
attractive. As a result, the opening up of capital markets is likely to remain limited in
ARTICLE IN PRESS
economies where political connections remain important (Stulz, 2005). To the extent that
foreign financing strengthens the competitive position of less connected firms, firms with
strong political connections can be expected to resist changes in domestic institutions that
facilitate global financing, such as increases in corporate transparency (Rajan and
Zingales, 2003). Institutional reform in this environment promises to be particularly
difficult because it is the firms with political clout that prefer less financial liberalization
(Chui et al., 2000).
A second conclusion relates to research on firms operating in relationship-based
economic systems. A growing literature investigates the performance effects of adopting
corporate strategies that are consistent with the Anglo-Saxon model of arm’s-length
finance. In many of these analyses, firms that pursue market-based strategies are compared
to firms that do not. To make valid empirical inferences, however, it is important to
recognize that these decisions are likely to be endogenously determined. In a relationship-
based economy, firms with weak connections (e.g., to political regimes or banks) have the
strongest incentives to rely on market-based transactions. Unless this is taken into account,
the debate about the performance and valuation effects of greater corporate transparency
and improved governance is likely to be misinformed.
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ARTICLE IN PRESS

Journal of Financial Economics 81 (2006) 411–439

Political relationships, global ﬁnancing, and

JEL Classifications: P16; G32; G38; K22; K42; M41; G18

Indonesia provides ample opportunity to study the performance consequences of

3. Sample and data

4. The choice of foreign securities

4.1. Main results

Closeness to Suharto 0.072 0.058 0.075

Cumulative returns on days

(1) (2) (3) (4) (5) (6)

Closeness to Suharto 4.018 4.021 4.618 5.042

H0: b^ 1 (age) ¼ 0 0.009 0.003 0.015 0.120 0.095 N/A

(1) (2) (3) (4) (5) (6)

(Volatility) (HK (SG returns) (D Rupiah) (D (Ext. Fin.)

Closeness to Suharto 4.371 4.866 5.186 5.822 5.623 5.424

4.3. Is closeness to Suharto endogenously determined?

5. Public and private foreign securities

(1) (2) (3) (4) (5)

Public U.S. Foreign Private Private Private U.S.

Closeness to Suharto 6.791 3.713 0.259 0.578 1.341

Observations 130 122 130 130 130

7/1/96–6/30/97 Pre-crisis 7/1/97–8/31/98 Mitton (2002)

(1) (2) (3) (4) (5) (6)

OLS 2-stage 2-stage OLS 2-stage 2-stage

Foreign securities 0.029 0.452 0.440 0.682 2.350 2.211

Observations 130 130 130 130 130 130

H0: fpre-crisis ¼ fcrisis 0.507 0.415 0.420

Finally, it is interesting to know whether the beneﬁts of having foreign securities

7. Dynamics of political relationships and foreign ﬁnancing

Pre-crisis vs. Pre-crisis vs. Pre-crisis vs. All periods

7/1/96–6/30/97 & 7/1/96–6/30/97 & 7/1/96–6/30/97 & 7/1/96–6/30/2001

(1) (2) (3) (4) (5) Firm-ﬁxed

Closeness to Suharto 0.952 0.654 0.956 0.809

Observations 251 233 225 488 488

Securities under Suharto and Wahid

Firms with foreign securities in Firms without foreign securities in

Changes in securities, by strength of connections

Firms close to Suharto Other Firms

Foreign securities in 2001 (but not Changes in new securities

Observations 101 122

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