Asian Review of Accounting

Why do firms appoint former military personnel as directors? Evidence of loan

interest rate in militarily connected firms in Indonesia
Iman Harymawan,
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ARA
26,1
2 rate in militarily connected
Received 28 July 2016
Revised 24 February 2017
22 June 2017
28 August 2017
Accepted 12 September 2017
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Asian Review of Accounting
Vol. 26 No. 1, 2018
pp. 2-18
© Emerald Publishing Limited
1321-7348
DOI 10.1108/ARA-07-2016-0086
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1321-7348.htm
Why do firms appoint former
military personnel as directors?
Evidence of loan interest
firms in Indonesia
Iman Harymawan
Department of Accounting, Universitas Airlangga, Surabaya, Indonesia
Abstract
Purpose – Anecdotal evidence shows that a number of military personnel have been appointed as board
members by listed firms in Indonesia. Taking advantage of the unique setting of the strong influence of
the military in Indonesian politics, the purpose of this paper is to provide direct empirical evidence on the
effect of military connections on interest rate for listed firms in Indonesia.
Design/methodology/approach – This study uses a sample of 1,818 firm-year observations of firms
listed on the Indonesian Stock Exchange (IDX) from 2004 to 2012 and employs Heckman’s two-stage
regression and Coarsened Exact Matching methods to address endogeneity concerns on the firms’
establishment of military connections.
Findings – The finding reveals that connected firms significantly enjoy lower interest rates on debt than
non-connected ones. These findings are robust to several robustness checks.
Research limitations/implications – The results of this study should be treated with caution since the
proxy of military connections limited only based on board connections. Hence, this may underestimate
the results from this study. This research has implications for Indonesia’s regulators who are striving to
improve accounting information and transparency of militarily connected firms.
Originality/value – The results of this study add to the literature that connected firms enjoy preferential
benefits provided by the connections through lower interest charges from banks.
Keywords Developing country, Bank loan, Interest rate, Military connections
Paper type Research paper
1. Introduction
A retired army general holds down the top position of president director. Yet he has never chaired a
shareholders meeting. He claims that while he signed cheques, loan application, and other
documents, he had virtually no idea what was going on McBeth (1994).
Prior studies document that the presence of militarily connected directors as board members
is one of the important determinants for explaining firms’ decision making and outcomes
(Benmelech and Frydman, 2015; Lin et al., 2011). This study extends the literature by
providing direct evidence of the effect of military connections to the interest rates in
developing countries.
Investigating the effect of military connections to business in developing countries is
important for several reasons. First, some developing countries (i.e. South Africa,
Pakistan, Libya, etc.) have shown that the military plays an important role in the political
decision-making process (Funnell, 2005; Shah, 2014). Although prior research shows that
political connections add value to connected firms around the world (Adhikari et al., 2006;
Fisman, 2001), these findings may not be generalizable in regard to the influence of
military connections in business. The involvement of military personnel in political
decision making provides an opportunity for the military to overuse their power.
They could serve a third party by utilizing their political and military power to gain
 private interests, especially in business. The lack of transparency and inefficient Militarily
government in most developing countries (Porta et al., 1997; Leuz et al., 2003) aid them in connected
establishing strong mutual business relationships. However, to my knowledge, there is no firms
empirical evidence of what the benefit is of being a militarily connected firm.
Second, examining the effect of military connections in business will further enhance our
understanding of what is the motivation of listed firms to appoint a board member with
military experience. In early 2016, the Indonesian Ministry of State Owned Enterprises 3
(SOEs) considered hiring former military personnel as board members in Indonesian SOEs.
However, it still remains an empirical question as to what is the motivation for listed firms to
appoint militarily connected directors. To fill the gap in this literature, this study aimed to
provide empirical evidence on this issue. Specifically, I investigated the firm debt interest
rate of militarily connected firms in Indonesia.
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I identified a unique setting of a country in which the military has played an important
role in politics. First, Indonesia is a country with enormous influence of the military over
the political decision-making process. Since its independence in 1945, Indonesia has been
ruled by presidents with a strong military background for 41 years[1]. Despite the military
reform that was enacted at the end of 2004, the military still dominates the political rivalry
in Indonesia. In the presidential election of 2004, two out of the five presidential candidates
were former military personnel[2]. Interestingly, all candidates in the presidential election
in 2009, either the president candidate or his (or her) running mate, were former military
personnel[3]. Therefore, up to now, Indonesia still has strong military involvements
in politics. Second, in the year 1957, the Indonesian Government issued a regulation
supporting and reinforcing the involvement of military personnel in economic activities in
Indonesia. Since that year, military business activities have emerged as one important
player in Indonesia’s economy.
Using this unique setting, this study aimed to provide empirical evidence on the
influence of military connections for listed firms in Indonesia. For the empirical analysis,
I constructed a sample of firms listed on the Indonesian Stock Exchange from 2004 to 2012.
I then examined the relations between the interest rate on debt of militarily connected firms
and non-connected ones. More specifically, I investigated whether firms with military
connections are associated with lower interest rates.
According to a rent seeking theory (Krueger, 1974), firms can seek a rent from someone
(i.e. politician, government official, etc.) to get some benefits (i.e. licenses, forestry
concession, etc.) from their connections to support their business. One good example in
Indonesia is when Golden Key Group borrows $430 million from a state-owned enterprise
that later became one of the biggest corruption scandals in the mid of the 1990s[4].
With the dual function military roles in Indonesia, it is possible that the military personnel
are able to give some benefits using their political power to the connected firms. If this is
the case, it is expected that the militarily connected directors can provide benefits for the
firms. As a result, militarily connected firms will have significantly lower interest rates
than non-connected ones.
Based on their military experience, military personnel are known to their good
leadership, discipline, and good organizational skill. Hence, alternatively, it is possible that
firms appoint militarily connected directors to get their leadership experience from the
military that might help to govern the firms better. In this case, we can expect that there is
no (or indirect) association between military connections and interest rate.
The results show that military connections are negatively and significantly associated
with interest rates. This indicates that banks charge lower loan rates for militarily connected
firms than non-connected ones. In other words, this finding suggests that the militarily
connected firms in Indonesia enjoy preferential treatment in regard to credit from banks.
Next, to address the potential influence of unobserved variables on the findings, I employed
 ARA Heckman’s two-stage regressions approach in this study. Similar to the findings in baseline
26,1 regression, I find that military connections are negatively associated with the interest rate.
Finally, due to another potential self-selection problem in regard to militarily connected
director appointments, it is also possible that the main findings were affected by the
observed variables included in the regression model. To address this potential problem,
I, therefore, re-examined the findings using the Coarsened Exact Matching (CEM) approach.
4 Under this approach, I found consistent results with the main findings which suggest that
the findings in this study are robust from self-selection problem.
As sensitivity checks, first I tested whether the results were affected by the crisis or
not. If the findings were not influenced by the crisis period, I expect to get similar results.
Second, I also conducted a test to examine the influence of the highest percentage of
militarily connected firms in the sample. Third, I also re-examined the regression models
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using an alternative proxy for the interest rate. In general, consistent with the main
results, the findings show that military connections are negatively associated with the
interest rate on debt.
This study adds to the literature in the following ways. First, the result of this study
sheds light on the benefits enjoyed by militarily connected firms in developing countries
(Crouch, 1978; Lowry, 1996; Mietzner and Misol, 2012). To my knowledge, this study is the
first empirical study to provide direct evidence that the presence of militarily connected
directors in listed firms is associated with lower interest rates on debt. Second, this study
also furthers our understanding of the motivation of listed firms in Indonesia when they
hire former military personnel as board members (Rieffel and Pramodhawardani, 2007;
Misol, 2006). Third, this study complements the prior studies in the bank loan literature
(e.g. Kim, Simunic, Stein and Yi, 2011; Kim, Tsui and Yi, 2011) by providing evidence on
the factors that might affect the level of bank interest rate in developing countries.
Finally, the findings in this study are also useful as a consideration for any institution
(private, public, or SOE firms) before they appoint militarily connected directors.
The remainder of this paper is structured as follows. Section 2 develops the research
hypotheses. Section 3 describes the sample and variables. Section 4 specifies the empirical
models and presents the main results and the results of the sensitivity tests. Section 5
summarizes the paper and presents concluding remarks.

2. Literature review and hypotheses

This section discussed the institutional background information about Indonesia and
hypothesis development. I examined the relation between military connections and the
interest rate on debt for Indonesian listed firms. Before describing the hypotheses,
I presented the institutional setting in Indonesia and discussed several arguments behind
the appointment of military personnel as board directors.

2.1 Institutional setting

The main reason for the involvements of military personnel in business in Indonesia was
due to the shortfall of the government’s budget for the Indonesian military (Crouch, 1975,
1979; Misol, 2006). In 1999, the military expenditure was US$1.649 billion or equal to
0.9 percent of the Indonesian gross domestic product. This amount was to cover the security
for a 1.8 million square mile area and 302,000 armed forces personnel. In comparison,
Singapore has a budget approximately four times bigger (US$4.481 billion) to cover
690 square mile of land and 73,000 armed forces personnel. Asmarani (2005) reported that
the budget allocated to the Indonesian Military only covers 30 percent of its spending.
The remaining 70 percent comes from off-budget sources. Therefore, it is not surprising to
still see a massive involvement of the military in Indonesian economic activities thus far.
 Prior research documents several types of benefits provided by the military in business. Militarily
Robinson (1986) found that military officers have unlimited access to the resources and connected
facilities of the state. They use this access to give benefits to their business partner. firms
In general, there are two types of advantages provided by military connections to their
partners in business. First is “facilitations” (Crouch, 1978; Lowry, 1996; Mietzner and
Misol, 2012). In the partnership with local or Chinese businessmen, the role of military
officers is to ensure that necessary licences[5] such as export or import licences, forestry 5
concessions, monopoly rights, and so on are available for their partner. Furthermore,
military officers can also assist in securing preferential financial access and government
contracts. Besides administrative “facilitations,” the military also able to provides assistance
such as the resolution of land disputes, calming of labor unrest, relocating squatters, and so
on, to ensure the smooth running of the business. The second aspect is “protection” either in
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legal business or when illegal activities[6] are involved. These types of relations can affect
firms’ decisions and outcomes in business.

2.2 Hypothesis development

This study focused on how the military connections affect the interest rate of connected
firms. Prior studies document that the quality of internal and external governance
monitoring mechanisms of firms influences the level of interest rate granted by banks.
Kim, Simunic, Stein and Yi (2011) found that voluntary auditing plays an important role to
enhance the credibility of financial statements, thus leading to a greater interest cost saving
for listed firms in Korea. Kim, Tsui and Yi (2011) also found that banks charge lower loan
rates to firms which follow International Financial Reporting Standards in their reporting.
Prior studies also document that political connections are able to provide some benefits
to connected firms such as preferential loan treatment and extract concessions, and win
government procurements (Agrawal and Knoeber, 2001; Backman, 2001; Goldman
et al., 2013). Ge et al. (2012) examined the relation between internal governance and bank
loan rates around the world. They found that banks perceive that a higher quality of
firm-level governance can improve credit quality. Interestingly, they found that this relation
is less strong in countries with weak institutions than in countries with strong institutions.
It is possible that by establishing political and/or military connections, firms in
developing countries can gain preferential access to financing. In other words, such
connections are substitutes for the quality of the governance needed by firms to reduce
the interest cost in developing countries. Prior research also finds that in Indonesia, the
military also plays a similar role as a politician providing benefit to their business
connections (Crouch, 1975, 1978). Using his/her (either or both) political and military
influence, the militarily connected directors can seek the support from the financial
institutions to give preferential financial access to the connected firms. If this is the case,
it is expected that militarily connected firms will enjoy lower levels of interest rate
compared to non-connected ones.
Alternatively, connected firms may enjoy another type of benefit than lower interest rate
such as leadership experience from CEO with military experience. Using US setting,
Duffy (2006) investigated the characteristics of firms with CEO with military experience for
S&P 500 firms. He found that CEO with a military background has more comprehensive
leadership skill (such as team work; good communication skill; organizational skill; defining
specific goals and empowering other to achieve it; a highly developed sense of ethics;
and ability to handle pressure) that can enhance the overall performance of the firms.
Benmelech and Frydman (2015), using the longer period of study for US firms, found that
firms with militarily connected CEO are able to mitigate fraudulent activity. They also
found that, based on their leadership experience, militarily connected CEO can help
the firms to perform better in an industry downturn. Despite a number of advantages of
 ARA CEO with military experience, however, there is no clear association between firms with
26,1 militarily connected CEO and loan interest rate. In one hand, it is possible that firms
with military experience CEO can indirectly benefit the lower of the interest rate of the firms.
In another hand, it is also possible that firms only benefit from their leadership role
without any association with the interest rate. Based on above discussion, I proposed the
following hypothesis:
6 H1. Firms with military connections exhibit a different level of the interest rate on debt
in comparison to their non-connected counterparts.

3. Sample and measurements

3.1 Sample and data
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The initial sample consisted of firm-year observations from the combination of OSIRIS
and the Indonesian Capital Market Data (ICMD) database for the period from 2004 to 2012.
The sample period started in 2004 because the initial data of interest rate spread (IRATE)
were available from 2003. I then deleted observations with missing data required for
regression analysis. I also deleted firm-year observations which have a different fiscal year.
Firms related to financial services were also excluded. Finally, I found 1,818 firm-year
observations as the main sample.
Table I presents firms’ distribution by the end of each year and industry. As shown in
Panel A, I found 86 firms (4.73 percent) to be militarily connected, suggesting that military
activism in business is less certain in public firms. This finding is consistent with prior
research that shows militarily connected firms are less transparent in order to avoid public
scrutiny (Misol, 2006). As shown in Panel B, I found most of the connected firms to be
involved in the construction industry. However, if we look at the percentage of connected
firms within the same industry, there is no big difference between industries. I found no
connected firms in service (seven) and health, legal, and educational service and consulting
(eight) industries. The highest percentage of connected firms is in the wholesale and retail
trade industry (five).
Indonesia is one of the countries which adopted two-tier board structure. In this type
of board structure, listed firms are required to have both a Board of Director and Board
of Commissioner (BoC). In China setting, BoC also called Supervisory Committee
(Firth et al., 2007; Cho and Rui, 2009). Based on data description in this study, all militarily
connected directors are serving as the BoC. All definition of variables used in this study is
provided in Table II.

3.2 Military connections measure

In this study, I constructed a military connections proxy from director biographies available
in the ICMD database. I manually extracted the name and background of each board
member for each firm-year observation. I defined a firm as militarily connected if it has at
least one board member with military experience. I labeled this proxy CONNECT.

3.3 Dependent variables

The dependent variable in this study was interest rate spread (IRATE), defined as interest
expenses in year t divided by the average of short-term and long-term debt at the beginning
and end of year t.
Table III presents the descriptive statistics, and Table IV presents the correlation matrix
for all variables used in the main analyses. As shown in Table III, the minimum and
maximum for interest rate are −0.272 and 0.184, respectively. With respect to total assets,
I found the minimum and maximum to be 471,975 and 1,078,333, respectively. Table IV
 Panel A: distribution by year-end
Militarily
Fiscal year Connection No connection All firms Percentage of connected
connected firms firms
2004 5 119 124 4.03
2005 6 121 127 4.72
2006 7 129 136 5.15
2007 9 192 201 4.48
2008 9 212 221 4.07 7
2009 12 212 224 5.36
2010 13 229 242 5.37
2011 12 243 255 4.71
2012 13 275 288 4.51
Total 86 1,732 1,818 4.73
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Panel B: distribution by industry

Connections No connections Total
Industry No. of firms % No. of firms % No. of firms
(SIC 0) Agriculture, forestry
and fisheries 4 5.71 66 94.29 70
(SIC 1) Mining 7 3.83 176 96.17 183
(SIC 2) Construction industries 44 6.74 609 93.26 653
(SIC 3) Manufacturing 8 1.88 417 98.12 425
(SIC 4) Transportation,
communications and utilities 8 4.44 172 95.56 180
(SIC 5) Wholesale and retail trade 15 8.62 159 91.38 174
(SIC 7) Service industries 0 0.00 126 100.00 126
(SIC 8) Health, legal, and
educational services and consulting 0 0.00 7 100.00 7
Total 86 4.73 1,732 95.27 1,818
Notes: The table displays the distribution of firms’ year observations with and without militarily connected
directors by year-end and by industry. The sample comprises all firms on the Indonesia Stock Exchange Table I.
(IDX) listed for the years 2004-2012. Individual director data are available from the Indonesia Capital Market Connected and
Data (ICMD) directory non-connected sample

presents the results from the correlation matrix of all variables used in this study. The result
shows that the proxy of military connections is negatively correlated with the interest
rate. From this univariate analysis, I found that the firms with military connections are
negatively associated with interest rate, have a negative return on assets, lower leverage,
and have a shorter distance from the headquarter to the military base in Indonesia. I also
found that militarily connected firms are associated with larger firm size, higher firm value,
and higher firm growth.
Table V presents the firms’ characteristics between connected firms and non-connected
firms. The table shows that connected firms have a significantly lower interest rate
(IRATE) than non-connected ones. With respect to SIZE, firms with military connections
are significantly larger than firms without military connections. For ROA, connected
firms have a significantly lower return on assets than non-connected ones. There is no
difference in firm leverage, market to book value ratio, and sales growth between
connected firms and non-connected ones. In addition, connected firms have a significantly
shorter distance between firms’ headquarters and Indonesian military bases than
non-connected ones.

4. Empirical results
In this section, I reported an empirical analysis which investigated the relation of military
connections to loan interest rate. In the first section, I presented the results from ordinary
 ARA Data
26,1 Variable Definition source

Dependent variable
IRATE ¼ Interest expenses in year t divided by the average of short-term and long-term OSIRIS
debt at the beginning and end of year t
AB_IRATE ¼ The difference between the interest rate for firm j in year t and the median of OSIRIS
8 interest rate within industry in year t (abnormal interest rate)
Test variables
CONNECT ¼ 1 for a firm with one or more directors who held military positions before sitting ICMD
on the board and otherwise 0
Control variables
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SIZE ¼ Natural logarithm of total assets OSIRIS

ROA ¼ Net income after preferred divided by average total assets for the year OSIRIS
LEVERAGE ¼ Total liabilities scaled by total assets OSIRIS
MKBV ¼ Market to book value OSIRIS
GROWTH ¼ The difference between total assets minus lag total assets scaled by total assets OSIRIS
MILLS ¼ The inverse Mills ratio OSIRIS
Selection model variables
PROBMC ¼ Percentage of militarily connected firms in the industry each firm belongs to –
Table II. DISTANCE ¼ Natural logarithm of the distance between the location of an Indonesian Military –
Variable definition base and the firm’s headquarters

Variable Mean SD Median Minimum Maximum

CONNECT 0.047 0.212 0 0 1

IRATE 0.022 0.067 0.028 −0.272 0.184
ROA 6 13 5 −36 51
TOTAL ASSETS 471,975 1,078,333 107,968 973 11,558,796
LEVERAGE 0.585 0.373 0.550 0.052 2.383
MKBV 2.134 3.163 1.200 −2.827 21.261
GROWTH 0.030 0.190 0.011 −0.376 1.067
PROBMC 0.047 0.040 0.050 0.000 0.200
DISTANCE 3.709 1.253 3.200 2.219 7.694
Notes: The table displays the descriptive statistics for all variables in this study. The sample comprises all
Table III. firms on the Indonesia Stock Exchange (IDX) listed for the years 2004 to 2012. Individual director data are
Descriptive statistics available from the Indonesia Capital Market Data (ICMD) directory

least squares (OLS) regression for main sample and subsamples. Next, I described the
results to rule out self-selection bias issues both for problems driven by observed and
unobserved variables. Finally, I provided some additional analysis as robustness checks.

4.1 Military connections and interest rate

4.1.1 Baseline regression and subsamples. In this section, I examined the relation between
military connections and interest rate using OLS regression. As shown in Table VI, I found
that the coefficient of CONNECT is negative and statistically significant. The results are
robust in any models with, partially, or without considering the effect of industry and year
trends by using industry and year fixed-effects. These findings indicate that firms with
military connections are associated with lower loan interest rate.
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(1) (2) (3) (4) (5) (6) (7) (8) (9)

(1) CONNECT 1,000

(2) IRATE −0.025 (0.284) 1,000
(3) SIZE 0.096*** (0.000) 0.033 (0.154) 1,000
(4) ROA −0.055** (0.019) −0.339*** (0.000) 0.244*** (0.000) 1,000
(5) LEVERAGE −0.013 (0.578) 0.203*** (0.000) −0.052** (0.025) −0.368*** (0.000) 1,000
(6) MKBV 0.007 (0.769) −0.066*** (0.005) 0.099*** (0.000) 0.323*** (0.000) −0.090*** (0.000) 1,000
(7) GROWTH 0.022 (0.359) −0.048** (0.042) 0.105*** (0.000) 0.138*** (0.000) −0.040* (0.089) 0.066*** (0.005) 1,000
(8) PROBMC 0.188*** (0.000) −0.020 (0.388) 0.074*** (0.002) 0.057** (0.015) 0.007 (0.770) 0.016 (0.506) 0.033 (0.156) 1,000
(9) DISTANCE −0.084** (0.017) 0.012 (0.725) −0.154*** (0.000) −0.050 (0.155) −0.112*** (0.001) −0.064* (0.068) −0.071** (0.045) −0.007 (0.835) 1,000
Notes: The table displays the Pearson correlation of all variables in this study. The sample comprises all firms on the Indonesia Stock Exchange (IDX) listed for the
years 2004 to 2012. *,**,***Significant at the 10, 5, and 1 percent levels, respectively
connected
Militarily

firms

Table IV.
9

Pearson correlations
 ARA Connection (n ¼ 86) No connection (n ¼ 1,732) Mean test Wilcoxon
26,1 Variables (mean) (mean) (t-statistic) (z-statistic)

IRATE 0.015 0.023 −1.05 −1.34*

ROA 3.032 6.457 −2.84*** −2.43***
SIZE 12.397 11.622 4.14*** 3.83***
LEVERAGE 0.563 0.586 −0.74 0.63
10 MKBV 2.232 2.129 0.35 0.52
GROWTH 0.048 0.029 0.7 −0.05
PROBMC 0.081 0.046 8.62*** 7.75***
DISTANCE 3.412 3.723 −3.35*** 0.74
Notes: The table displays the firm characteristics of firms with and without military connections on their
board in the cross-sectional sample in this study. The sample comprises IDX-listed firms from 2004 to 2012
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that are available from the Indonesia Capital Market Directory (ICMD) database and have financial data
available from OSIRIS. Military connections data were sourced from the ICMD database. Firm-level variables
Table V. are from OSIRIS. Models include robustness standard errors. Results of means t-tests and Wilcoxon (z-tests)
Firm characteristics are displayed. *,**,***Significant at the 10, 5, and 1 percent levels, respectively

IRATE
Variables [1] [2] [3] [4]

CONNECT −0.018** (−2.45) −0.017** (−2.43) −0.017** (−2.27) −0.016** (−2.21)

SIZE 0.005*** (5.63) 0.005*** (6.26) 0.005*** (5.34) 0.005*** (5.87)
ROA −0.002*** (−11.16) −0.002*** (−11.04) −0.002*** (−10.83) −0.002*** (−10.68)
LEVERAGE 0.015*** (2.85) 0.014*** (2.76) 0.015*** (2.81) 0.014*** (2.73)
MKBV 0.001** (2.26) 0.001** (2.51) 0.001** (2.52) 0.001*** (2.71)
GROWTH −0.004 (−0.43) 0.004 (0.48) −0.006 (−0.66) 0.003 (0.30)
CONSTANT −0.034*** (−2.89) −0.030** (−2.31) −0.010 (−0.78) −0.006 (−0.45)
Industry dummies Not included Not included Included Included
Year dummies Not included Included Not included Included
Adjusted R2 0.138 0.153 0.156 0.170
n 1,818 1,818 1,818 1,818
Notes: The regression models related to the military connections and firm-specific control variables for the
Table VI. main sample (n ¼ 1,811) in this study. The dependent variable is CONNECT. The sample comprises all IDX-
The results of listed firms from 2004 to 2012 that are available from the Indonesia Capital Market Directory (ICMD) database
regression on military and have financial data available from OSIRIS. Military connections data were sourced from the ICMD
connections and database. Firm-level variables are from OSIRIS. Standard errors are clustered by firm and year. z-statistics are
interest rate for the in parentheses. All continuous variables are winsorized at 1 percent and 99 percent levels. *,**,***Significant
main sample at the 10, 5, and 1 percent levels, respectively

It is possible that the negative association between military connections and interest loan
rate persist only in a specific condition. I, therefore, divided the main sample into two
subsamples based on the financial performance (ROA) and the size of the firm (SIZE).
Table VII presents the OLS results for subsamples. Specifications 1 and 2 examine the
hypothesis for the sample with return on assets above and below the median, respectively.
The results show an interesting finding. I found that in the first specification, the coefficient
of IRATE is negative (−0.029) and significant at the 1 percent level (t ¼ −3.46). However,
in the second specification, I found that the coefficient of IRATE is still negative (−0.000)
and but insignificant (t ¼ −0.03).
Next, I constructed the second subsample based on the size of the firm. Specifications 3
and 4 present the results for the sample with size above and below the median, respectively.
In the third specification, I found that the coefficient of IRATE is negative (−0.031) and
 IRATE
Militarily
[1] [2] [3] [4] connected
Variables High ROA Low ROA High SIZE Low SIZE firms
CONNECT −0.029*** (−3.46) −0.000 (−0.03) −0.031* (−1.71) −0.016** (−2.51)
SIZE 0.004*** (3.93) 0.006*** (4.12) 0.013*** (5.19) 0.001 (0.89)
ROA −0.001*** (−3.57) −0.002*** (−5.73) −0.002*** (−7.01) −0.002*** (−7.19)
LEVERAGE 0.002 (0.44) 0.038*** (3.28) 0.015** (2.45) 0.015 (1.48) 11
MKBV −0.000 (−0.17) 0.003*** (3.12) 0.001* (1.81) 0.002*** (3.13)
GROWTH −0.005 (−0.44) 0.01 (0.68) 0.006 (0.41) −0.007 (−0.68)
CONSTANT 0.028* (1.75) −0.044* (−1.77) −0.095*** (−3.11) 0.053** (2.4)
Industry dummies Included Included Included Included
Year dummies Included Included Included Included
2
Adjusted R 0.11 0.13 0.14 0.26
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n 909 909 909 909

Notes: The regression models related to the military connections and firm-specific control variables for the
subsamples in this study. The dependent variable is CONNECT. The sample comprises all IDX-listed firms Table VII.
from 2004 to 2012 that are available from the Indonesia Capital Market Directory (ICMD) database and have The results of
financial data available from OSIRIS. Military connections data were sourced from the ICMD database. regression on military
Firm-level variables are from OSIRIS. Standard errors are clustered by firm and year. z-statistics are in connections and
parentheses. All continuous variables are winsorized at 1 percent and 99 percent levels. *,**,***Significant at interest rate for the
the 10, 5, and 1 percent levels, respectively subsamples

significant at the 10 percent level (t ¼ −1.71). In the last specification, I found that the
coefficient of IRATE is still negative (−0.016) and significant at the 5 percent level
(t ¼ −2.51). Overall, the results in subsamples support the main findings that firms with
military connections are negatively associated with interest rate regardless the size of the
firms. Interestingly, these findings do not persist in a subsample of firms with return on
assets below the median. It indicates that connected firms cannot get the benefit of lower
interest rate from their connections when they have poor firm performance.

4.2 Self-selection bias

Firms choose whether to establish military connections or not. Under this situation, it is
possible that unobserved characteristics of individual directors are correlated with both
dependent variables and the military connections variable. In this case, it is possible that
unobserved individual directors with military connections characteristics are the source of
the associations rather than military connections. If this is the case, the findings of this
study will suffer from self-selection bias. Similar to prior research, therefore, I employed a
Heckman’s two-stage model to address these issues (Kim and Zhang, 2016).
Following Petersen (2009), all regression specifications in this study, the t- and z-statistics
below the coefficients, are based on standard errors corrected for firm and year clustering.
4.2.1 First-stage regression: determinants of military connections activity in business.
Tables VIII and IX report the results of the first and second-stage regression on addressing
self-selection bias issue. In this section, I reported an empirical test conducted regarding the
association between military connections and interest rate. In the first-stage regression,
I specified the following regression model linking military connections with the control
variables and selection model variables as follows:
CON NECT ¼ b1 þb2 X jt þb3 Z jt þI NDU STRY FI X ED EFFECTS
þY EAR FI X ED EFFECTS þe (1)
where CONNECT is the military connections. The vector Xjt represents the set of control
variables in the regression. The vector Zjt represents additional selection model variables
 ARA Dependent variable: CONNECT
26,1 Variable (1) (2) (3)

DISTANCE −0.107** (−2.01) −0.108** (−1.99)

PROBMC 12.494*** (5.86) 12.529*** (5.81)
SIZE 0.162*** (4.58) 0.179*** (4.85) 0.169*** (4.45)
ROA −0.029*** (−6.34) −0.030*** (−6.03) −0.031*** (−6.14)
12 LEVERAGE −0.713*** (−3.30) −0.746*** (−3.30) −0.785*** (−3.47)
MKBV 0.029* (1.80) 0.033** (1.97) 0.031* (1.86)
GROWTH 0.368 (1.16) 0.312 (0.98) 0.279 (0.88)
CONSTANT −2.829*** (−4.99) −4.770*** (−8.03) −4.282*** (−6.70)
Industry dummies Included Included Included
Year dummies Included Included Included
2
Pseudo R 0.114 0.161 0.167
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Table VIII. n 1,811 1,811 1,811

First-stage probit
regressions: Notes: First-stage probit regression models related to the military connections, firm-specific control
determinant variables, and exclusion variables for the main sample (n ¼ 1,811) in this study. The dependent variable is
of the relation CONNECT. The sample comprises all IDX-listed firms from 2004 to 2012 that are available from the
between military Indonesia Capital Market Directory (ICMD) database and have financial data available from OSIRIS. Military
connections and firm connections data were sourced from the ICMD database. Firm-level variables are from OSIRIS. Standard
characteristics for the errors are clustered by firm and year. z-statistics are in parentheses. All continuous variables are winsorized
interest rate model at 1 percent and 99 percent levels. *,**,***Significant at the 10, 5, and 1 percent levels, respectively

Dependent variable: IRATE

Variable (1) (2) (3)

CONNECT −0.016** (−2.20) −0.018** (−2.45) −0.018** (−2.42)

SIZE 0.006*** (2.79) 0.004*** (3.58) 0.004*** (3.96)
ROA −0.002*** (−5.18) −0.002*** (−8.13) −0.002*** (−8.63)
LEVERAGE 0.011 (1.17) 0.019*** (3.30) 0.018*** (3.18)
MKBV 0.001** (2.47) 0.001** (2.15) 0.001** (2.31)
GROWTH 0.005 (0.46) −0.000 (−0.00) 0.001 (0.07)
MILLS 0.006 (0.41) −0.008* (−1.93) −0.006 (−1.58)
CONSTANT −0.026 (−0.53) 0.028 (1.32) 0.021 (1.02)
Industry dummies Included Included Included
Year dummies Included Included Included
Adjusted R2 0.170 0.171 0.171
n 1,811 1,811 1,811
Notes: Second-stage regression models related to the interest rate, military connections, and a set of
Table IX. firm-specific control variables for the main sample (n ¼ 1,811) in this study. The dependent variable is IRATE.
Second stage of The sample comprises all IDX-listed firms from 2004 to 2012 that are available from the Indonesia Capital
Heckman procedures: Market Directory (ICMD) database and have financial data available from OSIRIS. Military connections data
the relation between were sourced from the ICMD database. Firm-level variables are from OSIRIS. Standard errors are clustered
military connections by firm and year. t-statistics are in parentheses. All continuous variables are winsorized at 1 percent and
and interest rate 99 percent levels. *,**,**Significant at the 10, 5 and 1 percent levels, respectively

that theoretically are potential determinants of the relation between business and military
connections (Lennox et al., 2011). I followed prior research in political connections literature
(Kim and Zhang, 2016) to include two additional variables in the first-stage regression that
affect the dependent variable (loan interest rate) only through its effect on the variable of
interest (military connections).
Specifically, I included DISTANCE which was defined as the distance from a firm’s
headquarters to a military base in Indonesia and PROBMC representing the percentage of
 connected firms in each industry. Similar to Kim and Zhang (2016), I argued that both Militarily
exclusion variables have no direct impact on the interest rate other than the indirect connected
impact through military connections. In other words, I expected that the closer the firms
distance between firms’ headquarters and Indonesian military bases the greater
the chance of a firm being militarily connected. However, there is no clear reason why this
distance will affect the loan interest rate. Similarly, I expected that the higher the
percentage of connected firms in a specific industry the higher the chance of the firms in 13
that industry being militarily connected. Nevertheless, there is no clear reason why this
variable will affect the loan interest rate.
The results of the first-stage probit regressions are reported in Table VIII.
Three specifications are presented in the table. In the first specification, I included
DISTANCE as the exclusion restriction variable. In the second specification, PROBMC is
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included as the exclusion restriction variable. The third specification includes both
DISTANCE and PROBMC as exclusion restriction variables. I found that, in all
specifications, firm size is an important determinant of the likelihood of establishing
military connections. It shows that larger firms are more likely to be militarily connected
firms. Interestingly, firms with military connections also have a lower return on assets and
firm leverage. Militarily connected firms also have higher market to book value than
non-connected firms. As expected, I found that militarily connected firms are more likely
to be concentrated in some specific industries. Finally, firms with headquarters closer to
Indonesian military bases are more likely to establish military connections. The pseudo
R2 ranges from 11.4 to 16.7 percent.
4.2.2 Second-stage regression. To investigate the relation between military connections
and interest rate, I estimated the following second-stage regression equation:

I RATE ¼ b1 þb2 CON NECT jt þb3 X jt þb4 M I LLS jt

þI N DU STRY FI X ED EFFECTS þY EAR FI X ED EFFECTS þe (2)

where IRATE is interest rate and CONNECT is military connections. Using the estimation
results of Equation (1), I constructed inverse Mills ratios and included these ratios in the
second-stage regression (MILLS). If the connected firms enjoy a beneficial loan interest
rate, β2 would be expected to be negative and significant.
The control variables used in this model are based on previous literature
(e.g. Kim, Simunic, Stein and Yi, 2011; Kim, Tsui and Yi, 2011; Pittman and Fortin, 2004).
I controlled SIZE because prior literature indicates that larger firms are more likely to have a
higher bank loan spread (Pittman and Fortin, 2004). I also controlled for profitability
because normally banks will charge lower interest for profitable firms (Kim, Simunic,
Stein and Yi, 2011). Following prior research, I also controlled for firm profitability
(Kim, Song and Zhang, 2011). I used ROA as the proxy of profitability. I controlled
LEVERAGE as a proxy for the bankruptcy risk. Following Kim, Simunic, Stein and
Yi (2011), I controlled GROWTH to control the potential effect of a firm’s growth on the
interest rate. Finally, I also included year dummies and industry dummies based on
single-digit SIC code.
Table IX presents the results of the second-stage regression. Three specifications are
presented in the table. In the first specification, I used DISTANCE to construct an inverse
Mills ratio. In this specification, I found that the coefficient of IRATE is negative (−0.016)
and significant at the 5 percent level (t ¼ −2.20). In the second specification, I used PROBMC
to construct an inverse Mills ratio and found that the coefficient of IRATE is negative
(−0.018) and significant at the 5 percent level (t ¼ −2.45). Finally, using DISTANCE and
PROBMC as exclusion restriction variables to construct an inverse Mills ratio in
 ARA Specification 3, I found that the coefficient of IRATE is negative (−0.018) and significant at
26,1 the 5 percent level (t ¼ −2.42). These results indicate that the presence of former military
personnel as directors is related to a lower level of the interest rate on debt. These results
are consistent with prior findings which argue that one reason for firms hiring militarily
connected directors is due to the preferential treatment that these firms enjoy (Crouch, 1978;
Mietzner and Misol, 2012), specifically, lower loan interest rate on debt.
14 For the invers Mills ratio, I found that the MILLS constructed by DISTANCE is
insignificant. However, the MILLS constructed by PROBMC is marginally significant.
It indicates that DISTANCE is a better instrumental variable in explaining the relationship
between military connections and interest rate. In addition, when I used both DISTANCE
and PROBMC when constructing the MILLS, I found that the MILLS is insignificant.
With respect to control variables, Table IX shows that larger firms and firms with higher
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leverage and higher market to book value are significantly associated with a higher interest
rate on debt (Pittman and Fortin, 2004; Kim, Tsui and Yi, 2011). Firms with a lower return on
assets are significantly associated with a higher interest rate on debt. The coefficient of
inverse Mills ratio is only significant in Specification 2. Nevertheless, this study still found a
negative association between the interest rate on debt and military connections.
4.2.3 CEM. As an alternative approach to addressing the self-selection concern,
I employed a CEM approach. The difference between this approach and Heckman’s two-stage
regression is that CEM is focused on potential observed (rather than unobserved) variables
that might influence the results in ordinary regression. The popular approach that is used by
prior research in accounting research is Propensity Score Matching (PSM) (Cheng et al., 2012;
Kim and Shi, 2012; Lawrence et al., 2011). However, recent research found that this approach
has sensitivity problem (DeFond et al., 2016). They describe that the results of using PSM
depend on the PSM design choice, i.e. matching with or without replacement; the number of
additional variables in the model; the number of iterations; bootstrapping analysis. Another
important issue of PSM approach is “random matching” problem. Therefore, I employed CEM
that is not susceptible to the random matching problem.
Table X presents the result of regression of military connections on interest rate using
the CEM approach. The result shows that the coefficient of CONNECT is −0.022 and

Variable Pred. sign IRATE

CONNECT − −0.022** (−2.16)

SIZE ? 0.005*** (2.71)
ROA − −0.002*** (−5.31)
LEVERAGE + 0.014 (1.12)
MKBV + 0.001 (1.15)
GROWTH + −0.000 (−0.04)
CONSTANT ? 0.032 (1.15)
Industry dummies Included
Year dummies Included
Adjusted R2 0.219
n 894
Notes: Coarsened Exact Matching (CEM) model related to the interest rate, military connections, and a set of
Table X. firm-specific control variables for the matched sample (n ¼ 894) in this study. The dependent variable is
Results of IRATE. The sample comprises all IDX-listed firms from 2004 to 2012 that are available from the Indonesia
regression of interest Capital Market Directory (ICMD) database and have financial data available from OSIRIS. Military
rate on military connections data were sourced from the ICMD database. Firm-level variables are from OSIRIS. Standard
connections for the errors are clustered by firm and year. t-statistics are in parentheses. All continuous variables are winsorized
matched sample at 1 percent and 99 percent levels. *,**,***Significant at the 10, 5, and 1 percent levels, respectively
 significant at the 5 percent level (t ¼ −2.16). Consistent with the main findings, these results Militarily
show that militarily connected firms enjoy the lower interest rate of bank loan. This finding connected
implies that the result in the main model is robust from the effect of observed variables in firms
self-selection problem.

4.3 Additional test

In this section, I re-estimated Equations (2) using several alternative samples and 15
proxy for the interest rate. Table XI shows the results of robustness checks for the interest
rate. In the first specification, I excluded the industry with the highest percentage of
connected firms to test whether the results are driven by specific industry. As shown in
Table I, Panel B, wholesale and retail trade (SIC 5) is the industry with the highest
percentage of connected firms (8.62 percent). Under this category, I found that 174 firms
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belong to this industry. Thus, I found 1,644 firm-years as the final observation.
Supporting the findings of the main sample, I found that the coefficient of CONNECT is
negative and statistically significant.
Due to the impact and complexity of the financial crisis, it is possible that the findings
in the main result were affected by the crisis period. The second specification presents the
result after excluding the financial crisis period. I found that the coefficient of CONNECT
is continuously negative and significant even after excluding observations during the
crisis period. This finding indicates that the main results are robust to the effect of
the financial crisis.
Finally, I re-examined the relation of military connections with the interest rate on debt
using abnormal interest rate (AB_IRATE). As shown in Table XI in the third specification,
consistent with the main result, I found that the coefficient of CONNECT is −0.016 and
significant at the 5 percent level (t ¼ −2.21). In summary, the results in Table XI suggest
that the main results of this study are robust to a variety of sensitivity checks.

5. Concluding remarks
This study took advantage of the unique setting in Indonesia to assess the effect of the
presence of militarily connected directors on public firms regarding the loan interest rate.

Dependent variable: IRATE AB_IRATE

Variable Ex SIC 5 [1] Ex Crisis [2] [3]

CONNECT −0.020*** (−2.68) −0.015** (−2.10) −0.016** (−2.21)

SIZE 0.005*** (5.14) 0.004*** (4.23) 0.005*** (5.87)
ROA −0.002*** (−10.25) −0.002*** (−8.50) −0.002*** (−10.68)
LEVERAGE 0.013** (2.46) 0.007 (1.19) 0.014*** (2.73)
MKBV 0.001** (2.11) 0.001* (1.84) 0.001*** (2.71)
GROWTH −0.002 (−0.23) −0.01 (−0.75) 0.003 (−0.3)
CONSTANT 0.001 (0.09) 0.013 (0.89) −0.038*** (−2.74)
Industry dummies Included Included Included
Year dummies Included Included Included
Adjusted R2 0.164 0.132 0.153
n 1,644 1,396 1,818
Notes: OLS regressions related to the interest rate of debt, military connections, and a set of firm-specific
control variables for the main and several alternative samples. The sample comprises all IDX-listed firms Table XI.
from 2004 to 2012 that are available from the Indonesia Capital Market Directory (ICMD) database and have Results of regression
financial data available from OSIRIS. Military connections data were sourced from the ICMD database. Firm- of interest rate on
level variables are from OSIRIS. Standard errors are clustered by firm and year. t-statistics are in parentheses. military connections
All continuous variables are winsorized at 1 percent and 99 percent levels. *,**,***Significant at the 10, 5, and for alternative
1 percent levels, respectively samples
 ARA Using Heckman’s two-stage procedures, this study found that connected firms have a
26,1 significantly lower interest rate on debt than non-connected ones. The findings are robust
to endogeneity problem, alternative regression methods, and the use of several additional
tests. Moreover, the result of excluding the financial crisis period from the sample
also supports the main findings. In conclusion, the finding shows that militarily connected
firms enjoy the preferential treatment of lower interest rate on debt from the banks.
16 This study adds to the literature by providing direct empirical evidence for understanding
the benefit of being a militarily connected firm. In particular, the results of this study
provide useful insight into the channel of the benefit provided by military connections
and reveal the motivation behind connected firms hiring former military personnel as
board members.
I acknowledge some limitations of my study, which are potential avenues for future
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research. First, my definition of militarily connected firms on IDX-listed companies is

only based on board connections. This indicates that the analysis may underestimate the
results of this study. Second, I acknowledge that militarily connected firms sample
is relatively small due to the infrequent appointment of militarily connected directors
or due to the preference of connected firm to stay as private firms in order to avoid
public scrutiny.

Notes
1. General (retired) Soeharto (1967-1998); General (retired) Susilo Bambang Yudhoyono (2004-2014).
2. General (retired) Susilo Bambang Yudhoyono and General (retired) Wiranto.
3. General (retired) Susilo Bambang Yudhoyono, General (retired) Prabowo Subianto, and General
(retired) Wiranto.
4. See McBeth (1994) for the detail.
5. Detailed examples can be found in McBeth (2002), Rieffel and Pramodhawardani (2007), and
Crouch (1978).
6. A detailed discussion can be found in Crouch (1975, pp. 533-537).

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Corresponding author
Iman Harymawan can be contacted at: harymawan.iman@feb.unair.ac.id

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