The Invisible Handshake: Profits vs. Connectedness

Is it better to be smart or connected? In the world of Malaysian corporate finance, the answer might be "both."

Continuing with the theme of corporate connectedness, I have calculated various measures of network structure in Malaysia's listed companies to see if "social capital" translates into financial returns. I focus here on two metrics:

Degree: Simply the number of shareholders a company has. Think of this as raw popularity.
PageRank: Named after Google co-founder Larry Page, this algorithm ranks websites by importance. I applied this to the network of cross-shareholding to determine the quality of connections. A company owned by a major player (like Khazanah) gets a higher PageRank than one owned by obscure holding companies.

Figure 1: Visualizing the relationship between connectedness and returns.

The graph above confirms my hypothesis: importance attracts importance. Companies with high centrality are likely to receive more links from other nodes in the network, such as institutional investors.

Figure 2: Regression results for Returns on Shareholders' Funds (2015).

Does this matter for the bottom line?
I regressed Return on Shareholders' Funds (2015) against these network measures. The preliminary results (shown above) suggest a positive relationship: companies that are more central to the network tend to be more profitable.

The Chicken or the Egg?
This raises a question of causality. Are these companies profitable because they are well-connected (gaining access to resources), or are institutional investors simply good at picking winners?

Needless to say, there is an endogeneity problem here. Correlation is not causation. To determine if networking is a legitimate strategy for boosting ROI, I will need to use instrumental variables to isolate the direction of causality.

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