The Relationship Between Political Connections and the Financial Performance of Industries & Firms
The US federal government’s response to the financial crisis was an unprecedented increase in government subsidies, grants, and contracts given directly to specific private businesses. The terms “crony capitalism” and “cronyism” are now widely used to describe the modern relationship between government and private business.
The US federal government’s response to the recent financial crisis and recession has included an unprecedented increase in the amount of government subsidies, grants, and contracts given directly to specific private businesses. Not surprisingly, such intervention has led, in recent years, to increased attention to and scrutiny of the relationship between corporate interests and government interests. The correlation between the government funding or attention received by specific companies and their political connections and lobbying activity has been a subject of debate and media investigation. The Economist magazine featured a story showing how the 50 companies with the most intensive lobbying activities in the S&P 500 have outperformed the rest of the index by 11 percent per year.
The impact of corporate political activity has received considerable attention in recent academic literature. Using various measures of political connectedness (or activity), findings include a positive relationship between political connectedness and firm value (Faccio, 2006; Faccio and Parsley, 2009), a positive relationship between campaign contributions and future returns (Cooper, Gulen, and Ovtchinnikov, 2010; Claessens, Feijen, and Laeven, 2008) or excess returns (Hill, Kelly, Lockhart, and Van Ness, 2013), and a positive relationship between political connectedness and both receipt of government contracts and firm contributions to particular politicians (Tahoun, 2014; Duchin and Sosyura, 2012). These results suggest there is value for a corporation and its management in expending energy on developing and enhancing political connections. However, the evidence is mixed, and it is not clear whether the gains from such activity are based on market forces rather than political favoritism. In contrast to these papers, Hadani and Schuler (2012) document a negative relationship between firm performance and political relationships. Further research in the area illustrates a positive connection between the likelihood of receiving a government bailout and political connectedness (Faccio, Masulis, and McConnell, 2006; Duchin and Sosyura, 2012), a positive relationship between political connectedness and access to bank finance (Claessens, Feijen, and Laeven, 2008), and a negative relationship between the quality of earnings and political connections (Chaney, Faccio, Parsley, 2011).
A contrasting strand of the literature suggests that corporate political activity can lead to (or be associated with) agency costs (Kim, 2008; Coates, 2012). Furthermore, while Duchin and Sosyura (2012) find a positive relationship between political connectedness and receipt of funds under the Troubled Asset Relief Program (TARP), they also find that politically connected firms underperform unconnected firms, suggesting a distortion in investment efficiency. And while Tahoun (2014) finds a cyclical relationship between politicians’ stock ownership, firm contributions to politicians, and subsequent contracts to firms, he also finds a negative cyclical relationship. That is, politicians may also divest stock ownership and, when they do so, those firms stop contributions, lose future contracts, and exhibit poorer performance. Ultimately, the picture painted by existing literature is unclear, with mixed results. In addition, since the recent financial crisis, the scale and scope of both government subsidies and political lobbying has grown by orders of magnitude. Thus, it is not clear whether results on data from before the TARP and American Recovery and Reinvestment Act (ARRA) programs hold true using more recent data.
In this paper we empirically measure the extent to which both industry-level and firm-level performance is determined by political connections rather than the normal forces of the marketplace. Our measure of “cronyism” is based on lobbying expenditures, campaign expenditures, or a combination of the two. We specifically focus on lobbying expenditures for a large part of our analysis because, as discussed below, such expenditures have increased dramatically over our time frame. Further, recent literature reveals a strong connection between long-term political relationships and lobbying activity (Kostovetsky, 2011). We begin by examining data aggregated to the industry level on firm financial performance and executive compensation matched with data on political activities to see the extent to which the allocation of resources across industry sectors is distorted by political connections. We then examine similar firm-level data to see to what extent the relative performance of firms within each industry is influenced by political connections. Because some government policies benefit an entire industry while some benefit specific firms, the distinction and separate analyses are worthwhile.
Lastly, we investigate whether political activity has any relationship with CEO compensation. The idea here is that, if political expenditures represent an agency cost to shareholders, this might show up as rent extraction by the CEO. In other words, even if corporations benefit from political spending, those benefits may go primarily to management rather than to shareholders. This would be especially troubling because it could indicate market distortion as well as agency costs within a subset of firms. Few papers have examined the relationship between executive compensation and corporate political activity. Joskow, Rose, and Wolfram (1996) investigate the pay of CEOs of electric utilities by state. They find that, in states they characterize as more “anti-business,” electric-utility CEOs’ pay is lower than in states that are considered to have more favorable business conditions. More recently, Werner (2012) finds evidence to support a positive relationship between corporate political action committee (PAC) donations and executive compensation. Coates (2012) posits a positive association between managerial ambitions and firms’ political expenditures and finds that a significant number of CEOs who retired by 2011 obtained government positions after retirement. In this paper, we endeavor to expand on this related literature as well.
The summary of our findings is that, despite such increased involvement by government in the marketplace, and greatly expanded political activities of firms, we find little evidence to support the idea that political activity undertaken by corporations leads to improved performance for firms and their shareholders at both the industry and firm level. We do however find a robust and significant positive relationship between political activity and executive compensation. Therefore, while industry and firm-level performance are not robustly related to “cronyism,” executive compensation is—suggesting that any benefits gained from corporate political activity are largely captured by firm executives.