The Value of Political Connections: Evidence from Korean Chaebols Myung Sub, Choi Bachelor of Business in Finance, Queensland University of Technology Submitted in partial fulfilment of the requirements for the degree of Master of Business (Research) The School of Economics and Finance Faculty of Business Queensland University of Technology Brisbane, Australia March 2014 Keywords Political Connections Politically Connected Firm Politically Connected Business Group Spill Over Effect Business Group Chaebol Family Networks Korea ii Abbreviations CAR Cumulative Abnormal Return FISL Financial Industry Structure Law KIS Korea Investor Service KOSDAQ Korea Securities Dealers Automated Quotation KOSPI Korea Composite Stock Price Index KSE Korea Stock Exchange KFTC Korea Fair Trade Commission iii Abstract This thesis examines the value of political connections for business groups by constructing a unique dataset that allows us to identify the form and extent of the connections. Results show firms’ membership to family-controlled business groups (South Korean chaebol) play a key role in determining the value of political connections. Politically connected chaebol experience substantial price increases following the establishment of the connection than other firms, but the reverse is found for other (non-family-controlled) connected business groups. The results are robust when we define political connection at the business group level, suggesting that there is a spill over in the value of connections from the connected firms to other affiliate members in the same business group. Political connections established through marital networks and to powerful politicians are most valuable. iv Table of Contents Keywords ................................................................................................................................... ii Abbreviations ........................................................................................................................... iii Abstract ..................................................................................................................................... iv List of Tables ........................................................................................................................... vii List of Figures ........................................................................................................................ viii List of Appendices .................................................................................................................... ix Statement of Original Authorship .............................................................................................. x Acknowledgement .................................................................................................................... xi Chapter 1 Introduction .............................................................................................................. 1 1.1 Background and Motivation ........................................................................................ 1 1.2 Research Aims and Questions ..................................................................................... 5 1.3 Findings and Contributions ......................................................................................... 8 1.4 Thesis Layout ............................................................................................................ 10 Chapter 2 Literature Review ................................................................................................... 11 2.1 Introduction ............................................................................................................... 11 2.2 Definition of Political Connection ............................................................................ 12 2.3 Benefits and Costs of Political Connections ............................................................. 15 2.4 Stock Market Reaction to Political Connections....................................................... 21 2.5 Summary and Conclusion ......................................................................................... 26 Chapter 3 The Institutional Setting ......................................................................................... 29 3.1 Introduction ............................................................................................................... 29 3.2 The Political System in Korea ................................................................................... 29 3.3 Business Groups in Korea ......................................................................................... 31 3.4 Chapter Summary ...................................................................................................... 37 Chapter 4 Hypotheses ............................................................................................................. 38 4.1 Introduction ............................................................................................................... 38 4.2 Hypotheses ................................................................................................................ 39 4.3 Chapter Summary ...................................................................................................... 49 Chapter 5 Data and Research Method .................................................................................... 50 5.1 Introduction ............................................................................................................... 50 5.2 Measuring Connections with Chaebols and Politicians ............................................ 50 v 5.3 Research Method ....................................................................................................... 63 5.4 Control Variables ...................................................................................................... 70 5.5 Descriptive Statistics ................................................................................................. 71 5.6 Chapter Summary ...................................................................................................... 76 Chapter 6 Empirical Results ................................................................................................... 78 6.1 Introduction ............................................................................................................... 78 6.2 Univariate Results ..................................................................................................... 78 6.3 Multivariate Results .................................................................................................. 86 6.4 Summary and Conclusion ......................................................................................... 98 Chapter 7 Conclusion .............................................................................................................. 99 References .............................................................................................................................. 102 Appendices ............................................................................................................................. 108 vi List of Tables Table 3.1: List of Presidents and National Assembly of Korea................................30 Table 5.1: An Example of Political Connections in Business Groups.....................54 Table 5.2: Political Connections in Hyosung Group and Hankook Tire group…..55 Table 5.3: Top 30 Large Business Groups Ranked by KFTC in 2008.....................58 Table 5.4: Classification of Political Connections............................................................60 Table 5.5: Variables for Political Connections..................................................................62 Table 5.6: Sample Composition based on Event Date......................................................66 Table 5.7: Skewness/Kurtosis Tests for Normality of Average CAR (-10, +10)..............69 Table 5.8: Descriptive Statistics........................................................................................75 Table 6.1: Cumulative Abnormal Returns (CARs) around the Establishment of Firm-Level Political Connections........................................................................................82 Table 6.2: Cumulative Abnormal Returns (CARs) around the Establishment of Business Group-Level Political Connections..................................................................84 Table 6.3: Cumulative Abnormal Returns (CARs) around the Establishment of Firm-Level Political Connections for Each Political Event..................................................86 Table 6.4: Regressions of CARs around the Establishment of Firm-Level Political Connections......................................................................................................88 Table 6.5: Regressions of CARs around the Establishment of Business Group-Level Political Connections........................................................................................92 Table 6.6: GLS Regressions of CARs around the Establishment of Political Connections......................................................................................................94 Table 6.7: Regressions of CARs around the Establishment of Firm-Level Political Connections: Types of Connections.................................................................96 vii List of Figures Figure 5.1: Types of Relatives based on KFTC’s Classification........................................53