Political Connections and Distortions on Public Procurement Markets: Evidence from the Czech Republic

• Název práce v češtině: Politické konexe a jejich vliv na trh veřejných zakázek: případ České republiky
• Název v anglickém jazyce: Political Connections and Distortions on Public Procurement Markets: Evidence from the Czech Republic
• Klíčová slova: politické konexe, veřejné zakázky, obec, starosta, volby, politika
• Klíčová slova anglicky: political connections, public procurement, municipality, mayor, elections, politics
• Akademický rok vypsání: 2019/2020
• Typ práce: diplomová práce
• Jazyk práce: angličtina
• Ústav: Institut ekonomických studií (23-IES)
• Vedoucí / školitel: PhDr. Miroslav Palanský, Ph.D.
• Řešitel: skrytý - zadáno vedoucím/školitelem
• Datum přihlášení: 05.02.2020
• Datum zadání: 05.02.2020
• Datum a čas obhajoby: 15.09.2021 09:00
• Místo konání obhajoby: Opletalova - Opletalova 26, O105, Opletalova - místn. č. 105
• Datum odevzdání elektronické podoby: 26.07.2021
• Datum proběhlé obhajoby: 15.09.2021
• Oponenti: doc. Petr Janský, M.Sc., Ph.D.

Seznam odborné literatury

Core Bibliography:
1. Akey, P. (2015). Valuing Changes in Political Networks: Evidence from Campaign Contributions to Close Congressional Elections. The Review of Financial Studies, 28(11), 3188–3223.
2. Amore, M. D., & Bennedsen, M. (2013). The value of local political connections in a low-corruption environment. Journal of Financial Economics, 110(2), 387–402.
3. Baltrunaite, A. (2017). Political Contributions and Public Procurement: Evidence from Lithuania. Journal of the European Economic Association.
4. Baranek, B., & Titl, V. (2018). Political Connections and Competition on Public Procurement Markets. Manuscript presented at The Royal Economic Society Symposium of Junior Researchers 2018.
5. Faccio, M. (2006). Politically Connected Firms. American Economic Review, 96(1), 369–386.
6. Goldman, E., Rocholl, J., & So, J. (2013). Politically Connected Boards of Directors and The Allocation of Procurement Contracts. Review of Finance, 17(5), 1617–1648.
7. Ministry of Regional Development. (2018). Výroční zpráva o stavu veřejných zakázek v České republice za rok 2018.
8. Navrátilová, A. (2018). Does donating to political parties pay off? Evidence from the Czech Republic (Bachelor Thesis). Institute of Economic Studies, Charles University in Prague.
9. Palanský, M. (2014). Political Connections and Public Procurement: Evidence from the Czech Republic (Bachelor Thesis). Institute of Economic Studies, Charles University in Prague.
10. Palanský, M. (2018). The Value of Political Connections in the Post-Transition Period: Evidence from the Czech Republic (IES Working Paper 13/2018). Institute of Economic Studies, Charles University in Prague.
11. Palguta, J. (2016). Konkurence politických uskupení v obecních zastupitelstvech a veřejné zakázky (Study IDEA 14/2016). Praha: Národohospodářský ústav AV ČR, v. v. i.
12. Titl, V., & Geys, B. (2019). Political donations and the allocation of public procurement contracts. European Economic Review, 111, 443-458.

Sources mentioned in the proposal but not constituting the core bibliography:
13. Acemoglu, D., Johnson, S., Kermani, A., Kwak, J., & Mitton, T. (2016). The value of connections in turbulent times: Evidence from the United States. Journal of Financial Economics, 121(2), 368–391.
14. Duchin, R., & Sosyura, D. (2012). The politics of government investment. Journal of Financial Economics, 106(1), 24–48.
15. Transparency International. (2019). Corruption Perceptions Index 2019.
16. Wu, W., Wu, C., Zhou, C., & Wu, J. (2012). Political connections, tax benefits and firm performance: Evidence from China. Journal of Accounting and Public Policy, 31(3), 277–300.

Předběžná náplň práce v anglickém jazyce

Motivation:
The issue of possible linkages between political entities and firms has been widely discussed in both the media and academic environment. These connections can be abused and lead to political favours and advantages benefitting connected agents, which may give rise to unfair competition. Additionally, this can also question the independence of politicians and political institutions and consequently decrease overall political trust.
In order to quantify potential rent extraction, it is inherent to determine what can be considered as political connections and how they can be measured. Among the commonly used indirect measures are donations to politicians and political parties as data on donations are relatively accessible and allow to determine the real value of connections compared to binary indicators of connections. On the other hand, the use of such methodology may lead to the self-selection bias caused by the fact that better performing companies are simply more likely to donate money than worse performing ones. Studies incorporating donations as a proxy for political connectedness include, for instance, Akey (2015) in the USA, Baltrunaite (2017) in Lithuania or Palanský (2014), Navrátilová (2018) and Titl and Geys (2019) in the Czech Republic.
Despite the drawbacks of binary measures, many researchers have specified political connections through political persons themselves since it allows to capture connections in a rather direct manner. These include Faccio (2006), Goldman et al. (2013) and Baranek and Titl (2018) who have considered companies as being politically connected if their officials (board members, CEOs and others) were members of some political party and occupied a political position at the same time. Several studies, for example Amore and Bennedsen (2013) or Acemoglu et al. (2016), have dug even deeper by employing personal ties of individual politicians such as friendship or family relations. However, the collection of such data might be very time-consuming and even impossible given current personal data protection laws.
Previous research has demonstrated that connected agents may benefit from political connections in various ways. These involve indirect effects such as increased market capitalisation (Faccio, 2006), but also more direct channels such as easier access to government funding (Duchin and Sosyura, 2012) or lower effective tax rates (Wu et al., 2012). As municipal contracts are used, this study mostly contributes the to the string of literature focusing on the impact of political connections on public procurement spending.

Following that, Baltrunaite (2017) estimated that the probability of winning a public tender by firms who contributed to some political party decreased by 5 % after the ban on corporate donations was introduced in Lithuania. Goldman et al. (2013) found that the value of procurement supplied by firms connected to the Republican party increased significantly after the Republicans took over control of House and Senate in 1994. In the Czech Republic, Palanský (2014) and Navrátilová (2018) already showed that companies contributing to political entities received public procurement of higher value than their non-contributing rivals, though they focused on tenders at the regional and governmental level, respectively. Using public procurement awarded by local authorities, Palguta (2016) further revealed that chances of donating firms to gain contract decreases with the increasing number of parties controlling the municipality. Palanský (2018) also showed that politically connected firms significantly outperformed their non-connected rivals and he further estimated this effect to be stronger for companies operating in procurement-intensive industries, pointing to the fact that procurement contracts are likely to serve as a source through which corporate entities make use of their connections.
In this thesis, we thus attempt to extend existing literature by focusing on political connections, which are defined in several ways, and their impact on Czech public procurement administered at the municipal level. Primarily, we focus on the indirect specification of connections (as explained in the Methodology section of this proposal). Additionally, we aim to extend the analysis using other proxy variables such as political donations or direct connections with elected politicians.

Hypotheses:
Hypothesis #1: Politically connected companies supply, on average, public procurement of higher value.
Hypothesis #2: Companies connected to politicians holding the mandate in local governments receive, on average, public procurement of higher value during the period when they are connected.
Hypothesis #3: Companies which donate more to political parties obtain, on average, public procurement of higher value.
Hypothesis #4: The presence of politically connected companies reduces competition in procurement tenders.

Methodology:
We develop several empirical hypotheses to test the impact of political connections on the allocation of municipal procurement. From the side of political linkages, we mainly focus on indirect connections by dividing data on public procurement into two or three terms between respective municipal elections and then defining entity as being politically connected if it supplied procurement contract in the respective political term. Using artificially created panels, we can thus track overall changes between these periods.
To do so, we firstly need to determine which political parties were elected to respective municipalities during these terms. If possible, we attempt to narrow this definition by considering only political parties which were in power, i.e. we focus on parties whose members occupied major positions in local governments such as the mandate of mayor or mandates in city councils. We will then compare the extent to which connected firms supply public procurement before in municipalities in which the mayor changed in elections and those in which the mayor stayed the same.
The basic information about results of municipal elections and political composition at respective municipalities will be obtained from the Czech Statistical Office (Volby.cz) using a Python-based scraper, and from open data of the Czech Ministry of the Interior. Details about occupied positions in local governments will be further extracted from individual websites of municipalities.
In the second part of this study, we would like to focus on other sources of political connections either by incorporating indirect connections through donations to elected political parties or direct connections through elected politicians. In the latter case, this would be accomplished by matching elected politicians with companies’ officials, since we plan not only to collect information on political parties, but also on respective politicians.
Data on public procurement, other data such as firm characteristics, and, if employed, data on political donations will be obtained from the civic organisation EconLab, z.s. This entity collects data from the Commercial Register, the site vestnikverejnychzakazek.cz, and the database PolitickeFinance.cz, which retrieves information from the annual reports of political parties. Regarding the methodology from the statistical point of view, basic methods such as comparative statistics, OLS and pooled OLS are going to be used.

Expected Contribution:
First important contribution of this study can be perceived in the data collection. The Ministry of the Interior provide information only about the current mayor in individual municipalities. Our objective is to collect information on the political structures of past municipal representation and merge these into one comprehensive dataset. Consequently, we believe that such data can be then useful for further research related not only to political connections.
The next contribution is the analysis of the effects of political connections itself. Considering the case of the Czech Republic, similar research has been already conducted using both public procurement as a channel of rent extraction, though administered mostly at regional or governmental level, and various proxies of political connections. However, to the best of my knowledge, there is no empirical research studying the effect of political connections according to our main indirect definition as well as the overall impact on public tenders allocated at the municipal level.
Finally, there are several reasons why the Czech Republic represents a suitable candidate to test these effects. Firstly, previous studies already demonstrated that political connections are more likely to be observed in countries suffering from corruption and weaker institutional framework. According to the periodical study of Transparency International (2019), the Czech Republic took 44th place in the Corruption Perceptions Index, obtaining only 56 from 100 points. Together with findings of previous studies and individual instances presented by media, it is likely that political connections are present and perhaps even exploited in the Czech Republic more than in other countries. Secondly, the Czech procurement market represents a significant share of GDP (around 11.76% in 2018; Ministry of Regional Development, 2019). Considering its long-standing non-transparency, it seems that it constitutes a channel through which entities may extract benefits from political connections. Thirdly, we perceive this type of analysis as being of high importance and that it should be conducted regularly by economists or political scientists as it represents the way how the general public can oversee politicians.

Outline:
1. Introduction
2. Literature review (Foreign literature: Defining political connections, Benefits from political connections; Political connections and public procurement in the Czech Republic)
3. Czech political background (Public procurement, Political environment – functioning of municipal institutions and municipal elections)
4. Data description (Data collection process – municipal elections, local councils and majors, and individual candidates; Data description – public procurement, political donations – if employed; Other data sources)
5. Methodology (as in the Methodology section of this proposal)
6. Results and Discussion (Comparison to the previous Czech and Foreign studies, ideas for future research)
7. Conclusion