BYU and MIT Professors Link Political Favors to Stock Values

Journal of Financial Economics, February 2003

PROVO, Utah — Feb 05, 2003 — Having friends in high places has its benefits, and in Malaysia the benefits are worth billions.

Brigham Young University and MIT researchers recently measured the impact of cronyism — favoring friends and political allies — on Malaysian companies' stock values. Their research showed that companies with political connections regained stock value much more quickly than other companies, following restrictions imposed by the government during the East Asian economic crisis of the late 1990s.

"We found that during the crisis, companies with political connections experienced a much stronger rebound in their stock prices than companies that didn’t have these connections," says Todd Mitton, assistant professor of business management at BYU’s Marriott School and co-author of a new study which appears in the February issue of The Journal of Financial Economics.

Prior to the crisis, companies in Malaysia enjoyed the benefits of their connections, but when hard times hit, a shrunken tax-base limited the ability of government officials to grant favors to their cronies. To combat the effects of the major economic slump, the Malaysian government instituted strict capital controls, limiting the flow of money out of the country and providing officials with more resources to help their friends.,p>Once capital controls were instituted, stock prices at firms with connections to Prime Minister Mahathir quickly began to rebound. “This suggests the market recognized that implementing capital controls was a way for the government to give support to favored companies,” Mitton says.

"During the first part of the crisis, politically connected firms in Malaysia lost about $60 billion in market value,” he says. “When capital controls were implemented by the Malaysian government in September 1998, companies with close ties to Mahathir gained about $5 billion in market value in that one month."

Mitton and his co-author, Professor Simon Johnson of MIT, attribute about 9 percent of the initial $60 billion lost by connected firms during the economic crisis to a reduction in the expected value of government benefits. They estimate that 32 percent of the $5 billion market value increase that followed the implementation of capitol controls can be attributed to a rise in the perceived value of political connections to the prime minister.

Using statistical regression analysis, the researchers compared the stock performance of companies connected to the prime minister with those lacking such connections – controlling for other characteristics that affected stock performance during the period.

"Malaysia is one of few countries that have experimented with capital controls recently," Mitton says. "So, it’s a good case study if you want to look at the combination of capital controls and cronyism."

The Marriott School is located at Brigham Young University, the largest privately owned, church-sponsored university in the United States. The school has nationally recognized programs in accounting, business management, public management, information systems, organizational behavior and entrepreneurship. The school’s mission is to prepare men and women of faith, character and professional ability for positions of leadership throughout the world. Approximately 3,000 students are enrolled at the Marriott School’s graduate and undergraduate programs.