Effect of Political Actors on Small Firms' Business Relationships and Performance

Abstract preview

Effect of Political Actors on Small Firms’ Business
Relationships and Performance

-A Case of EU and Swedish Small Firms


ABSTRACT


Despite the statement of many researchers and politicians on the vital role of SMEs for their
contributions to GNP and employment, the research on SMEs relationship with political
organizations is left almost untouched. This paper highlights the effect of political organizations like
EU, on SMEs business performance. With emphasis on the effect of political unit on long-term
business performance, the focus of this study is on how political units influence small firms.
Employing business network theory, the stress is on the effect of political relationship and the
connection on business relationship and finally business performance. It develops a theoretical view
and examines how the coercive/supportive behaviour of political units affects directly and indirectly
on business performance. While the direct effect refers to the direct relationship between the political
and business units, the indirect relationship concerns the effect via coercion or support of business
relationship. For the direct and indirect relationship effect on business performance the study has
developed 4 hypotheses which will be tested by results from a survey involving from 134 SMEs in
Sweden. Using PLS for statistical analysis, the article highlights the importance of a firm’s business
relationships in both being affected by coercive actions by political organizations and also in
receiving the full benefit from their supportive actions.

Keywords: business performance, SMEs, business relationships, political connections, coercive and
supportive behaviour, the European Union

AUTHORS
Amjad Hadjikhani

Firouze Pourmand
Department of Business Studies
Department of Business Studies
Uppsala University, Sweden
Uppsala University, Sweden
amjad.hadjikhani@fek.uu.se
firouze.pourmand@fek.uu.se

Peter Thilenius
Department of Business Studies
Uppsala University, Sweden
peter.thilenius@fek.uu.se

Introduction

Despite the statement of many researchers (e.g., Corbetta and Montemerlo, 1999) on the vital role of
SMEs in both Europe and USA for their contributions to GNP, employment and wealth creation, the

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research on SMEs relationship with political organizations is left almost untouched. The failure in
incorporating the impact of political organization into the studies on small firms is founded in the
view that small firms operate in local markets and have to follow the political rules, no matter were
these political units are situated. This study postulates that small firms’ business performance is
confronted with uncertainty from not only their domestic country’s political organizations but also
from those in other countries or unions like the EU. The lack of studies on such business realities has
motivated this study to focus on the question of how SMEs business performance is affected by the
political organizations like the EU. Authors like Ring et al. (1990); Hadjikhani and Ghauri, (2001);
Welch and Wilkinson (2004), claim that the scope of marketing literature contains no more than a
handful of research, based on systematic investigations, pertaining to interactions between firms and
political units. Researchers state that there is a considerable knowledge gap between the firms’
practices of the political market and the availability of sound, research-based insights and principles.
Furthermore, the available studies seldom touch upon SMEs and their embeddedness in the
international political environment; and more specifically situations where SMEs are active in a local
market and have no foreign operation. In line with this reasoning, the study by Hadjikhani and
Ghauri (2001) demonstrates how Swedish firms make large commitments to influencing the political
units in the EU before political decisions are made. To explicate, the higher the influence, the more
specific support the firms gained.
Research on business network theory, like the studies of Welch and Wilkinson, (2004) and
Hadjikhani and Thilenius, (2005), promote the view that the business performance of a business unit
is related to its business relationship and connections. In this vein, the theoretical foundation of this
study is composed of three analytical units; the firm’s business performance, the focal business
relationship and the political connection. The firm’s business performance is proposed to be affected
by the political connection both directly and indirectly through the impact on the focal business
relationship.
The effect of political units can be studied their coercive and supportive actions towards the
business firms (Hadjikhani and Thilenius, 2005). In the few available studies, SMEs are explained as
being adaptive because of their resource scarcity (Ojala and Tyrväinen, 2008; Hadjikhani et al.
2006). While large business firms have organized units and commit resources towards the political
organizations, SMEs have to undertake costly, adaptive actions (Prashantham, 2005; Hadjikhani and
Ghauri, 2001). One major goal of SMEs in their interaction with political units is to avoid
uncertainty and gain support for their businesses. Tackling the political environment is vital as
SMEs, contrary to large business firms, do not have sufficient internal resources. While MNCs can
undertake proactive actions to manage the political uncertainty and gain support, SMEs are regarded
as being passive and adaptive.
SMEs have been extensively researched in many different fields. While some studies concern
issues like entrepreneurships in international environments, or the role of social capital for small
firms (Westerlund and Svahn, 2008), others concern topics like internationalization (Coviello and
Munro, 1997; Hohental, 2001), and foreign market entry (Ojala and Tyrväinen , 2008). These
attempts reflect issues like SMEs and the firm-level factors such as resources and knowledge (see for

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example, Bell 1995, Prashantham, 2005). The vital role of SMEs and political impact has recently
drawn the attention of some researchers (Hadjikhani and Ghauri, 2001; Crane and Desmond, 2002).
In these efforts the environment of SMEs reflects business issues like production scheduling or
firms’ strategy and environmental uncertainty or the manufacturing environment, using technical and
financial risk management. The political environment is studied by the hierarchical power of political
units on manufacturing or financial issues. In the views developed, the unit of analysis is the firm and
not the business relationships. Further, the uncertainty that reaches SMEs emanates from local, often
domestic, political units.
A study like this one can contribute knowledge not only to the research community but also to
the SMEs, managers and practitioners, who thus gain a more systematic understanding of their
relationships in the socio-political market. The present study goes beyond this mainstream and
assumes that SMEs are interwoven in a network containing both business and non-business actors
(Welch and Wilkinson, 2004). As stated by Welch and Wilkinson (2004) such interdependency calls
forth studying how political organization effect on business firms.

Theoretical Frame and Hypotheses
Constructed on business network theory (Håkansson, 1999; Ford, 1990) this study frames the link
between business performances and the political relationships. It departs from the view that
mutuality and long-term relationship in business network theory contains a function that preserves
the gain of each of the individual firms. It rests on the view that long-term business performance of
every business unit is prerequisite to operate in a business network context. The presumption sets
business performance in focus while relationships and network activities occur as means to preserve
the firms’ long-term gain. Following the statement of researchers like Welch and Wilkinson (2004)
and Hadjikhani and Thilenius, (2005) business network context is explained to encompass
relationships with both business and non-business actors. In this vein, business firms are
interdependent on the political actors as they can gain support or be hindered, and political actors are
directly and indirectly interdependent on SMEs as they are the major source for the increase in GNP,
jobs and the development of local industries. Thus, the business performance of each individual unit
is in this context an outcome of the relationships with actors belonging to different structures.
Business performance relies in this perspective on the effects from both business and non-business
interactions. The view is delimited to studying the so called ‘political market’ while denoting the
effect of political actions on business performance. It follows the assumption that political actors
have two possible routes of interaction with every individual business actors. Business performance
is in one way affected by the direct relationship between political and business actors and in another
way through by the connection via the business relationship. The political connection can either be
supportive or coercive. The effect of this connection can either be direct or indirect through the
connection to business partners. Business performance is regarded as an output of the firm’s direct
relationships with business relationships and by the political connection.
With emphasis on firms’ performance researchers like Hsu et al. (2008) state that business
performance as antecedent to the firms’ relationships and network. Business performance, viewed in

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this perspective, highlights the issue of longevity in business development. Rather than financial
performance, revenues, market shares and return on investments, measures (Rust et al., 2004)
relating to short-term performances, business capabilities and aspects like non-financial performance
are elevated as alternatives for the study of business performance (Tseng et al., 2009). Indicators like
capability in product development and technological development (Ford, 1990; Håkansson, 1982) or
knowledge development in the firm (Olavarrieta and Friedman, 2008) which explain the business
long-term growth and survival of the firms are well disposed to measure the business performance.
In this study, these indicators are presumed to be effected not only by business operations but also by
the effect of political relationships.
The notion of political effect relies on assumption that political actors are dependent on SMEs as
firms make investments that affect realm of the political units and that these firms are dependent on
political units for their support and for market stability. Following the reasoning on business
relationships the actions of political organization can be explained as coercive or supportive
behaviour in the relationships while the act of business units can be observed as influence or
adaptation. Supportive actions are assumed to promote the enhancement of the firm’s business
performance, while coercive actions are associated with the contradictory reduction of the business
performance. The notion of coercion implies the exercise of legitimate power to force business firms
to follow the political decisions. The adaptive behaviour of SMEs will eventually increase the costs
and reduce the business gains. The supportive rules or financial support on the other hand will have
positive effects and increase the firms’ performance. The Green Paper of the EU in 2001, for
example, concerns the issue of an integrated product policy (Zackrisson, et al., 2008), an attempt to
support in some fields and hinder in other fields. The effects of political coercive actions on MNCs
are presumed by some researchers to be lower compared with SMEs. SMEs, because of their size
and low managerial resources, have to adapt their organizational structure and business relationships
(Hadjikhani and Ghauri, 2005). However, these firms also make investments in fields like lobbying
to affect the political units (Hadjikhani and Thilenius, 2005a; Hadjikhani and Ghauri, 2001; and
2008). Some, like Henisz (2003), and Coen, (2001) presume lobbying and influence on political
organizations (Ghauri and Hadjikhani, 2006) as managerial actions to build relationships with these
units and gain support. In a relationship setting, the possible actions are to; a) change the coercive
behaviour or; b) strengthen the supportive behaviour (Hadjikhani and Ghauri, 2001). The
accumulation of coercive/supportive and adaptation/influence in this interaction is manifested as
positive/negative consequences on the firm’s business performance. Furthermore, this accumulation
of behaviour can be the result of direct effects on business performance or indirect effects through
business relationship. In Figure 1, the political connection’s effect on firms’ performance is
illustrated as two functions, one direct on focal firms’ business activity and one indirect mediated by
the business relationship support and coercion.

Figure 1: Political Connection and the effects on firm’s business performance

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Indirect effect
through Business
Relationship
Support

Political
Firm’s Business
Direct
Connection
Performance
effect
Indirect effect
through Business
Relationship


Accordingly to Boddewyn (1994) and Easton (1992) direct and indirect functions can have positive
or negative effects on business firms. While supportive actions promotes the business performance
and gains, coercive actions reduces the business gains. The coercive view implies the exercise of
legitimate power to force business firms to follow the political decisions. The first hypothesis
concerns the direct function which implies that political actions contain a degree of specificity with
directly effect on each business units individually. Undoubtedly, for the relationship logic this will in
turn effect on business relationship (this effect is not included in this study). In terms of relationship,
business firms’ undertake actions to gain specific influence by either lobbying/negotiation or are to
adapt themselves. While the primary action, like negotiation is to keep the mutuality in the
relationship, the latter manifests a coercive relationship. The assumption in the relationship between
the political and business firms is to connote the degree of direct effect on business performance.
This relies on specificity in the relationship between the two. Obviously, this effect will subsequently
create obstacle or new opportunities for the firms’ business relationship. The hypothesis in the
following regards this direct effect and mean to study the strength of the direct effect of political
connection on firm’s business performance.

Hypothesis 1: The stronger the political connection the higher the direct effect on firm’s business
performance

The indirect effect resides on the logic of business network as any action of the interactive parties
affect and become affected by political units. Specific or general effect from political units on
interactive parties’ relationship will ultimately effect on business performance. No matter the degree
of the specificity or the degree of the strength in coercive or supportive act of political units, business
relationship becomes affected. While some actions strengthen the business relationship, others
weaken it. Supportive behaviour can aid business relationships and strengthen them while coercive
behaviour on the contrary can weaken them. Ultimately, each of these imposes specific effects on
business performance. Business relationships function in this line of reasoning is as a conduit

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creating indirect effect of political connection on firm’s business performance. Firms’ long-term
technological investment for new technologies and product development or even short-term return on
investment, is postulated as an outcome from relationships with both business and political actors. In
this regard the following three hypotheses refer to two different aspects. One is in regard to the effect
of political connection on the business relationship and the other two refers to the direct effect of
political connection on business performance via the business relationship. The first examines the
strength in coercive and supportive behaviour on business relationship strength. The next two
concerns the strength in the political effects in support or coercion of business relationship and then
on business performance.

The stronger indirect connection, resides on business relationship will ultimately effect on
business performance. No matter the degree of the specificity or the degree of the strength in
coercive or supportive act of political units, business relationship becomes affected. While
some actions strengthen the business relationship, others weaken it. Supportive behaviour can
aid business relationships and strengthen them while coercive behaviour on the contrary can
weaken them. Ultimately, each of these imposes specific effects on business performance.
Business relationships function in this line of reasoning as a conduit between the political
connection and firm’s business performance creating an indirect effect of political connection
on firm’s business performance. Deviation of support and coercion of business relationship is
to study the degree of effect of each one on business performance. Firms’ long-term
technological investment for new technologies or products and short-term return on
investment, is postulated as an outcome from business and political relationships. In this
regard the following three hypotheses refer to two different aspects. One is in regard to the
effect of political connection on the business relationship and the other two refers to the effect
of political connection on business performance via the business relationship. The first
examines the strength in coercive and supportive behaviour on business relationship strength.
The next two concerns the strength in the political effects in support or coercion of business
relationship and then on business performance.

Hypothesis 2: The stronger the political connection, the higher the effect on business relationship
support and business relationship coercion

Hypothesis 3: The stronger the political connection, the higher the indirect effect mediated by
business relationship support on firm’s business performance

Hypothesis 4: The stronger the political connection the higher the indirect negative effect mediated
by business relationship coercion on firm’s business performance


Method

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This research is part of a broader project aiming at substantially increasing our knowledge on the
effect of political activities towards business actors and the effect on business relationships and firm
performance. In this context, a questionnaire was designed to collect data on a variety of topics
related to these issues. The questionnaire consists of four parts; 1)) EU’s influence on the
relationship between the firm and the specific, chosen business partner;; 2)) EU’s influence on the
focal business;; 3)) the relationship towards the chosen business partner, without inference from the
EU, and finally;; 4)) the role of intermediaries such as politicians on local and national level as well
as trade organisations. All variables were measured on a five-point ordinal scale.
The chosen setting for this study is Sweden and particularly SMEs. Following the EU definition of
SMEs, e.g. firms with more than 10 and less than 50 employees, a turnover of a maximum of 10
million Euros, a sample frame was drawn from a Swedish database covering all Swedish firms.
During the sampling process there were no consideration taken to the geographical dispersion of the
sample unit. The questionnaire was pre-tested and some minor modifications were made to correct
phrasings and ambiguous questions to exclude erroneous indicators. The data collection was done in
Sweden, the late quarter of 2008 and the language was Swedish. An introductory letter was attached
to the questionnaire with information about the purpose of the study, the contributions to research
and the practical knowledge that it will bring to the business community. Some additional
information about the sampling procedures, on how the anonymity of the respondents will be taken
into consideration, how the results are going to be used and also information about how to fill in the
actual questionnaire was also included. A pre paid envelope for returning the questionnaire on
completion was also sent along with the self administered mail questionnaire. Finally, data from 124
SMEs were collected.

Data analysis technique
To assess construct validity and test the hypotheses, SmartPLS version 2.0M3 (Ringle, Wende and
Will, 2005) were used. PLS, partial least squares are a statistical technique built on structural
equation modelling and is preferably more appropriate when sample sizes are small, exploratory
and/or assumptions of normal distributions are not satisfied (Chin and Newsted, 1999). The method
of employing PLS for analysis follows a two-step approach. The first step comprises the assessment
of the measurement model, i.e. the reliability and validity of the constructs. The second step involves
specifying a structural model which is evaluated in terms of the strengths of the causal relationship.

Data analysis and results
In the analysis, the business relationship support and coercion and business performance were all
operationalised as latent variables, i.e. the values of the indicators of a construct are assumed to be

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caused by the latent variable and thus co-vary reflecting the level of the latent variable. The
independent variable, denoted Political effect, is measured by three indicators forming a construct
relating to the support from EU for business, the investment of specific resources to handle EU rules
and regulation and also the level financial resources spent on political issues. The other constructs
are formed in the same manner all with four indicators respectively to measure the latent variable.
Business relationship support is measured through indicators on business development, taking
advantage of business opportunities and the long-term development of the business relationship.
Business relationship coercion is indicated by the negative effect of EU on the business relationship,
the impact of rules and regulations, the difficulties in handling EU-issues and the extremity of EU-
demand on the business with the business counterpart. Finally, the firm’s business performance is
measured by the creation of new business opportunities, the facilitation of product development, the
increase of profitability and technical development. In table 1 below, all indicators of latent variables
and constructs are displayed together with their mean, standard deviation, factor loading, the
reliability coefficient and the average variance extracted (AVE) of latent variables.


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Table 1: Means, standard deviations and factor loading for all constructs
Construct
Factor
Mean
S.D.
Indicator1
loading
Business relationship support (Reliability2=0.83; AVE=0.66)



1. EU makes that we can develop our business with our business 2.21
1.17
0.80
counterpart
2. Issues discussed in EU affect the development of the 2.64
1.15
0.73
relationship with our business counterpart
3. We and our business counterpart have taken advantage of 2.38
1.18
0.85
the opportunities created by EU
4. Long-term EU will have a positive affect on how our relationship 2.73
1.07
0.86
with our business counterpart will develop




Business relationship coercion (Reliability=0.87; AVE=0.72)



1. Issues discussed in EU have an negative effect on the 2.04
1.09
0.74
relationship with our business counterpart
2. EU’s rules and regulations has forced us to extensive changes in 2.00
1.16
0.86
our business with our business counterpart
3. Handling EU-issues in the relationship with our business 1.82
1.00
0.91
counterpart is troublesome
4. EU often poses preposterous demands that we have to follow 2.00
1.10
0.87
in the business with our business counterpart




Firm’s business performance (Reliability=0.75; AVE=0.58)



1. EU has created new business opportunities
2.79
1.27
0.80
2. EU has simplified product development for us
2.22
1.05
0.81
3. EU has a positive effect on our business profitability
2.35
1.00
0.78
4. EU has a positive effect on our possibilities for technical 2.63
1.12
0.64
development




Political connection (Reliability=0.59; AVE=0.56)



1. We often get support from EU for our business
2.08
1.08
0.62
2. We invest specific resources for handling EU rules and 1.93
1.18
0.88
regulations
3. We spent a lot money on political issues
1.70
0.98
0.72

Following the suggestions in Comrey and Lee (1992) that factor loadings of 0.71 are considered
excellent, 0.63 as very good, 0.55 as good, 0.45 as fair and finally loadings below 0.32 as poor, we
can state that all variables in Figure 3 above are interpreted. The reflective measurements in the
model have all very good to excellent factor loadings. The individual loadings varies from 0.62, as
being the smallest loading value, to 0.92 as being the largest factor loading value. The recommended
value for the reliability coefficient (Cronbach’s alpha) is 0.7. The value for all latent variables is
exceptionally on a satisfying level and above the recommended value. The AVE is recommended
that for every construct, more than 50 percent of the variance should be explained, e.g. to be higher
than 0.5. In the table above, AVE is higher than 0.5 for all variables and shows that the values are
satisfactory for the purposes of this analysis.


1 Translated from Swedish original. phrasing in English may differ slightly in some cases
2 Cronbach’s Alpha

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Table 2: The latent variable correlation matrix: discriminant validity –squared latent variable
correlations (off-diagonal elements) versus AVE (diagonal elements)

Construct
Business
Business
Firm’s
Political
relationship
relationship
business
connection
coercion
support
performance
Business
relationship 0.85



coercion
Business
relationship 0.42
0.81


support
Firm’s
business 0.09
0.63
0.76

performance
Political connection
0.51
0.48
0.50
0.75
Square root of AVE on the diagonal. correlations off-diagonal

In assessing the discriminant validity among the latent variables the square-roots of the AVE of each
latent variable was calculated from the PLS-output and compared to the correlations among the same
variables. From the outcomes displayed in Table 2 above, it can safely be concluded that the
discriminant validity is satisfactory in all cases as the square-roots of the AVE of the latent variables
are larger than the correlation among them. Following this step in the analysis, a structural model
encompassing the hypothesised causal relations was specified and tested in PLS. The results for the
output for the analysis are displayed in Table 3 below.

Figure 3: Structural model
Business
0.48
0.59
relationship
(6.57)
(8.94)
support

Political
Firm’s business
connection
0.41
performance

(5.18)

0.51
-0.37
Business
(5.55)
(4.61)
relationship
coercion

Note: β-coefficients with t-values in parenthesis

In figure 3 above, the output from the statistical computations of path coefficient and their statistical
significance in PLS is displayed. The figure shows that all hypothesises are considered to provide
adequate evidence of the predictive ability of the model and are statistically significant. The model
also shows an R2 of 54.2% for firm’s business performance. Furthermore, the output shows that the

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