Firms’ Strategic Use of Political Connections

Abstract

This paper examines how a firm’s political connections in a location influence the firm’s choice of the location to establish new subsidiaries. First, using political connections incurs a cost in that politicians can demand connected firms to engage in economically-inefficient but politically-desirable tasks such as hiring superfluous labor. As a result, the firm is least likely to choose a politically connected location that also faces the economic conditions, such as higher unemployment or higher fiscal deficits, that commonly propel politicians to make such demands. Second, more “outside options” of obtaining the economic benefits conferred by political connections, such as from more developed product and factor markets, lowers the importance of choosing a politically connected location. Therefore, how firms utilize their political connections is highly context-dependent.