The Rise of a Network: Spillover of Political Patronage and Cronyism to the Private Sector

The misallocation of government resources to the politically connected is considered to impose substantial economic costs. We document that resource misallocation to the politically connected extends to resources allocated by private sector firms. Following the presidential election in 2007, private banks in Korea appoint executives from the new president’s alumni network in an effort to establish links to the new administration. In turn, private banks that appoint executives from the president’s alumni network allocate more credit to firms with links to the same network through their CEOs. Additionally, in-network firms pay lower interest rates and are protected from default through debt restructurings. Exploiting variation for the same firm across different lenders over time allows us to control for firm-time fixed effects, sharpening the identification of the results. We estimate that private banks incur aggregate losses equivalent to 4.5 basis points of GDP due to preferential treatment of in-network firms.