LAUSR

(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONThe impact of being politically connected firms has been widely discussed in the literature. Wu et al. (2010) explain that based on the resources-based view theory, political connections are a resource that are difficult or costly for other firms to get thus its possession is a source of competitive advantage. Political connections are more useful for firms in which politics is an important determinant of their profitability (Agrawal and Knoeber, 2001). Some also argue that being politically connected are valuable for firms as their connections may provide "privileges" such as prevent them from competition, could create industry barrier to entry, more likely to be bailed out and improve access to resources. On the other side, however, it could also be argued that political connections could be a burden for a firm as the connections may create well-performed firms that dependent on favorable government policies. It thus causes them more susceptible to the political issues, political changes or regulatory reforms.Access to financing is the main benefit that has been widely studied (Khwaja and Mian, 2005; Fraser et al., 2006; Charumilind et al., 2006; Li et al., 2008; Claessens et al., 2008), as it could be argued that political figures in the firms can use their power to obtain access of financing, especially bank loan. Other benefits of being politically connected that have been studied in the literature are better performance and higher market value (e.g. Du and Girma, 2010; Goldman et al., 2009) and lower cost of equity capital (Boubakri, 2012). On the other hand, however, the opponents argue that political connections may create well-performed firms that dependent on favorable government policies. It thus causes them more susceptible to the political changes or regulatory reforms (Leuz and Oberholzer-Gee, 2006). Several empirical studies also show the negative impacts of political connections for firms, such as increasing cost of debt (Bliss and Gul, 2012), risky and can hurt performance (Lux et al., 2012) and increasing audit fees (Gul, 2006; Wahab et al., 2009).1The present paper investigates the impact of being politically connected banks on performance and cost of funding. We focus on banking firms as there are only few papers that have studied political connections in the banking industry (e.g. Carretta, 2012; Polsiri and Jiraporn, 2012; Disli et al., 2013; Prabowo, 2013; Nys et al., 2015). Carretta et al. (2012) focus on the impact of connections on intermediation activities, while Disli et al., (2013) and Nys et al. (2015), based on market discipline and implicit guarantee perspective, highlight the effect of political connections on depositor behaviors especially with regards to shifting of the deposit insurance system from blanket guarantee to limited guarantee system. Similarly, Polsiri and Jiraporn (2012) emphasize on the role of political connections on failure likelihood of banks. Prabowo (2013) examines the moderating effect of political connections in the effect of family ownership on bank performance.Our paper focuses on the benefits of being politically connected banks, more specifically on cost of funding and ultimately on performance. We argue that politically connected banks are benefited in term of getting lower interest on deposits as they might be perceived as less risky by depositors because the government would most likely rescue them when they face financial distress (Braun and Raddatz, 2010; Nys et al., 2015). Being politically connected might also ease banks to have larger access to fund particularly from government budget and state-owned enterprises projects with a lower interest rate. Moreover, they could also charge a higher interest on loan as they are supposed to have a higher market power which subsequently could improve performance.Going deeper, we look at the difference effect of political connections of foreign and private banks. …