Does Financial Globalization Discipline Politically Connected Firms?

Abstract:     
This paper studies one channel that affects the impact of financial globalization on the allocation of capital within countries. We show empirically that, in countries with weaker overall governance, politically connected firms benefit relatively more of financial integration than other firms. They experience a positive differential effect on investment, which seems to be financed by a differential increase in debt, and especially short-term debt. This differential effect on investment is accompanied by a negative differential effect on reported profits. These results are not consistent with an unconditional "discipline effect" of international financial integration on the allocation of capital domestically. On the contrary, they suggest that country characteristics are key: capital inflows, might, under certain circumstances, lead to a misallocation of capital. We provide a theoretical explanation for these results emphasizing the governance of domestic banks and firms relationships, and the "uninformed" characteristic of foreign capital.

Keywords: financial globalization, corporate governance, political connections

JEL Classification: G21, G30, F30, O16, O43

working papers series