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How political connections shape firm outcomes in Germany

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Continuous scrutiny of political influence in business is crucial to ensure fair competition and efficient market outcomes 

Connections between firms and political power are observed worldwide, raising questions about their impact on economic efficiency and fairness. Some argue that political connections can mitigate market failures, but empirical evidence largely shows that these connections are often exploited for preferential treatment and favoritism. This can lead to a misallocation of resources, as politically connected firms gain undue advantages in government contracts, loans, and subsidies.

There is limited empirical evidence on how political connections shape firm dynamics, especially concerning high-level federal politicians. Our recent IZA Discussion Paper explores the German context to answer how having a current or former member of parliament on a firm's executive team impacts the company’s performance. Germany, with its robust institutions and low corruption levels, provides a unique setting for this examination. German laws and regulations are strict, limiting direct political influence on firms, yet politicians often hold seats on company boards. Unlike other countries, the German system explicitly allows federal politicians to hold high-level firm positions under full disclosure obligations.

We built a comprehensive dataset linking information on all members of the Bundestag (Germany’s federal parliament) since 1949 with firm ownership and executive positions. We use data from various sources, covering firm outcomes such as credit scores, employment, sales, government subsidies, and public procurement contracts. Our setting allows us to exploit the timing of political mandates and firm positions to define events for identifying causal effects on firm outcomes. First, we use an event study design, comparing firms that newly appoint politicians with similar firms appointing non-politicians. This method assumes the timing of appointments is independent of anticipated outcomes. To address potential biases, we develop a strategy based on election outcomes, focusing on the random nature of winners in ranked candidate lists submitted by political parties before elections. Here we compare firms gaining a connection by candidates just winning a seat to firms with candidates who are just losing.

Our findings reveal several key insights. Firstly, the number of German firms connected to high-level politicians has substantially increased over the past two decades. Secondly, political connections boost firms’ credit ratings, protecting connected firms from failure, as they experience fewer exits in the years after gaining a connection. This observation aligns with literature finding that stock market returns increase after a firm becomes politically connected. Thirdly, appointing politicians to the executive team positively impacts employment growth, but there is no evidence of corresponding productivity growth. Fourth, evidence on effects on government subsidies and procurement contracts is mixed.

In summary, our research provides new evidence on the influence of political connections to high-level politicians in Germany, highlighting the role of credit ratings in firm performance. Our research underscores the need for continuous scrutiny of political influence in business to ensure fair competition and efficient market outcomes.

© André Diegmann, Laura Pohlan, and Andrea Weber 

André Diegmann is Head of Research Group at Halle Institute for Economic Research (IWH) and Senior researcher at the Institute for Employment Research (IAB)  
Laura Pohlan is Senior researcher at the Institute for Employment Research (IAB) and IZA Research Affiliate
Andrea Weber is Professor of economics at the Central European University and IZA Research Fellow

Please note:
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.

Related IZA World of Labor content:
Political connectedness and formal finance in transition economies by Kobil Ruziev
Does corruption promote emigration? By Friedrich Schneider
Bosses matter: The effects of managers on workers’ performance by Kathryn L. Shaw

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