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Do political connections affect the market reaction to firms’ inclusion in or exclusion from the Sharia index?

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Abstract

Previous studies have clearly documented the shareholder advantages and disadvantages of political connections. However, evidence of the role of political connections in ethical investment is scarce. This study investigates the relationship between political connections and the reconstructions of the Sharia index in Indonesia. Using the event study methodology, I evaluate the abnormal returns surrounding the announcement of the inclusion or exclusion of firms in or from the Indonesia Sharia Stock Index (ISSI). I further conducted a regression analysis to enhance the identification of the relationship between political connections and Sharia compliance. Neither the inclusion nor exclusion of firms in or from the ISSI yields abnormal returns, indicating that investors are not very concerned about ISSI reconstitutions. Political connections increase firm value before their inclusion in the ISSI. However, the benefits of such connections are lost after their inclusion in the ISSI. Meanwhile, I find no evidence of a relationship between political connections and the market reaction surrounding the exclusion of firms from the ISSI.

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Data Availability

The datasets generated during and/or analyzed during the current study are available from the corresponding author on reasonable request.

Code Availability

Not applicable.

Notes

  1. ISSI is a composite index of Sharia shares listed on the Indonesia Stock Exchange (IDX); it serves as a performance indicator of Indonesia’s Sharia stock market. The IDX launched the ISSI on May 12, 2011.

  2. The qualitative parameters comprise activities that do not contravene Islamic principles. In other words, the firm should not conduct prohibited business activities such as selling alcohol, gambling, taking bribes, and paying or charging interest. Meanwhile, the quantitative screening measures are implemented to ensure that the firm’s financial ratios are tolerable. A firm must confirm that the level of interest-based debt and percentage of non-permissible revenue does not exceed the threshold. If a firm’s business activities contradict Islamic principles, or their financial ratio exceeds the threshold, they are excluded from the Sharia Index.

  3. OJK Regulation No. 35/POJK.04/2017 on the Criteria and Issuance of the Sharia Securities List.

  4. Halal means permissible according to Islamic law.

  5. The annual reports provide the profiles of the board of commissioners and the board of directors. Hence, we can identify whether or not the board of commissioners and the board of directors have connections to the politicians. In addition, I matched several profiles of the board of commissioners and the board of directors provided in the annual report with the firms’ official website and Forbes magazine, especially to identify one of the criteria for political connections, i.e., “close relationships with top officials” (the detailed explanation of the criteria for political connections is presented in Sect. 3.2.2).

  6. There is a skewness bias in my data. Therefore, following Lyon et al. (1999), to eliminate the skewness bias, I use a bootstrapped skewness-adjusted t- test in my analysis.

  7. Relationships are classified as friends or well-known associates who are connected with a political party (Faccio, 2006).

  8. It means from sixty days to one day before the ISSI reconstitutions.

  9. The “–” and “+” signs describe before and after. For example, [–5, 0] and [0, + 5] mean five days before and five days after the ISSI reconstitutions, respectively.

  10. For instance, while quantitative screening in Indonesia does not include restrictions on accounts receivable and cash, the Dow Jones Islamic Index screening criteria restrict both.

  11. See OJK Regulation No. 35/POJK.04/2017 and OJK Regulation No. 15/POJK.04/2015.

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Acknowledgements

I thank Professor Kengo Shiroshita, Professor Katsuya Yamamoto, Professor M. Kabir Hassan (editor), and two anonymous referees for their valuable and constructive suggestions.

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This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

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Authors and Affiliations

  1. The Graduate School of East Asian Studies, Yamaguchi University, Yamaguchi, 753-8514, Japan

    Budi Wahyono

  2. Department of Economics Education, Universitas Sebelas Maret, Surakarta, 57126, Indonesia

    Budi Wahyono

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Wahyono, B. Do political connections affect the market reaction to firms’ inclusion in or exclusion from the Sharia index?. Eurasian Bus Rev 13, 835–854 (2023). https://doi.org/10.1007/s40821-023-00249-0

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