The Effect of Political Connections: Model Analysis and Quantitative Simulation

Based on a two-task principal-agent theoretical models, we model the input of building and maintaining political connections as non-productive activities. We measure the degree of change in the external environment. And the level of moral hazard on political connection managers is measured by the degree of incongruity between a politically connected manager’s income and investor interest. Our analysis using a quantitative simulation shows that, in the face of more external environmental change, managers can offset their own lost income by engaging in a high level of moral hazard. Political connections not only increase managers’ sensitivity to changes in the external environment but also alleviate the negative impact on their income. Moreover, investor revenue is not sensitive to changes in the external environment but is sensitive to managers’ moral hazards. In addition, the greater the changes in external environment and the greater the managers’ moral hazards, the lower the value of total social welfare. Hence, political connections have a negative impact on total social welfare.