Report Number

2007-008

Abstract

Recent studies have documented systematic exchanges of favors between politicians and firms, and that connected firms, on average gain from political ties. Since these ties are often to a top manager or large shareholder, agency problems are likely more severe for politically connected firms. Moreover, in the case of political ties, the costs of lower quality disclosures may be mitigated. Empirically, we find that the quality of earnings reported by politically connected firms is significantly poorer than that of similar nonconnected companies. Additionally, among connected firms, those that have stronger political ties have the poorest accruals quality. This evidence suggests that managers of connected firms appear to be less sensitive to market pressures to increase the quality of information. This choice seems to be justified in that lower quality reported earnings is associated with higher cost of debt only for the nonpolitically connected firms in the sample.

Date of this Version

2007

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