Assessing the Relationship Between Corporate Political Connections and Financial Reporting Quality in Public Enterprises

Posted: Mar 18, 2024

• Michael Johnson
• Michael Ramirez
• Michael Williams

Abstract

This study investigates the complex relationship between corporate political connections and financial reporting quality in publicly traded enterprises, employing a novel methodological framework that integrates network analysis, natural language processing, and machine learning techniques. Unlike previous research that primarily focused on binary measures of political connections, we develop a multidimensional political connectedness index (PCI) that captures the depth, breadth, and strength of corporate-political relationships across multiple dimensions. Our analysis of 2,500 publicly traded companies over a ten-year period reveals a nuanced relationship where moderate political connections correlate with improved financial reporting quality through enhanced regulatory awareness and compliance mechanisms, while excessive political embeddedness demonstrates diminishing returns and, in extreme cases, negative effects on reporting quality. The research introduces an innovative text-mining approach to measure the quality of management discussion and analysis (MDA) sections as a proxy for reporting transparency, revealing that politically connected firms exhibit more boilerplate language and less substantive disclosure despite meeting formal reporting requirements. Our findings challenge the conventional wisdom that political connections uniformly degrade financial reporting quality and instead suggest a more complex, curvilinear relationship moderated by corporate governance mechanisms and institutional oversight. This study contributes to the literature by providing a more sophisticated measurement framework and revealing the contextual factors that determine when political connections serve as complements or substitutes for high-quality financial reporting.