Politically connected outside directors and market reaction: evidence from Korea

Using a sample of Korean-listed firms, this study investigates whether there is an association between political connections and market reaction. Specifically, we examine the association between the appointment of politically connected outside directors (PCODs) and cumulated abnormal returns and whether politically connected directors affect stock price crash risk. We find that firms appointing PCODs experience a negative market reaction on the announcement date of hiring them. However, firms with PCODs on the board are less likely to experience stock price crash risks. These results can be interpreted as follows: when firms appoint politically connected directors, investors initially criticise this event as political ties may corrupt fair trade. However, it may also be argued that firms with political connections have incentives to improve accounting transparency due to negative public concerns for a possible back-scratching alliance between the government and businesses and attract greater public attention from the media and investors. In other words, although PCODs may impose a negative perception on investors, these directors may contribute to their firm by playing a significant role in advising and/or protecting the firm using their previous work experience and connections.