Essays on finance and politics

This dissertation examines two important aspects of politics in modern corporate financial theory namely, political risk, and political connections, from perspectives that have not yet been explored in prior literature. The first issue of political risk is relevant to firm-level political risk and its’ impact on corporate tax avoidance. This study finds strong evidence that firms reduce tax avoidance activity in the presence of heightening firm-level political risk. This relation is robust to measures used to address endogeneity concerns and absolved of accrual managements. The findings also show that US firms are more tax-sensitive to heterogenous political risk, compared to firms in countries mandated by the International Financial Reporting Standard (IFRS). Further analysis reveals that the motivation for tax compliance under political pressure is stronger for financially unconstrained firms, socially responsible firms, and high market power firms. The second issue of political risk is concerned with the broader level of political risk, namely geopolitical risk (GPR), and how it impacts firm value, focusing on non-financial firms from 17 emerging market countries. This study finds strong evidence that when GPR heightens, firm value is reduced, as firms conservatively manage their financial activities and investment decisions amid the uncertainty and higher costs of capital. The findings also show that the detrimental impact of GPR on firm value is mitigated for firms in emerging countries with stable politics, robust socioeconomic and where rules of law are respected. The other aspect of politics in modern corporate finance address in this dissertation is the role of political connections on stock returns during the political crisis. Using Hong Kong 2019 political conflict between the pro-democracy citizens and the Chinese government as the main setting, this study contributes to the ambiguous empirical findings of political connections in the prior findings and finds that firms in Hong Kong can utilize political connections with the Chinese government to reduce the impact of heightening political instability on their stock return and accounting performance. Political connections allow them to increase their financial leverage and obtain a more favorable debt maturity structure during times of financial distress. The findings also show that political crisis impacts domestic firms more than their highly internationalized counterparts. Taken together, the findings suggest that during the time of political crisis, political connections can mitigate the adverse effect on stock performance, especially for firms that are limited by their ability to internationally diversify.