Tuesday, July 25, 2006

More political connections = higher returns

I imagine this one will be making the rounds in the popular press relatively quickly. It is by Goldman, Rocholl, and So.

The super short version of their paper is that having a board member with ties to the political party in office is good for shareholders (which probably is more disappointing than shocking).

A slightly longer version:

The authors begin by stating that "in countries with a well functioning legal system the preferential treatment of companies due to their political ties should not be widespread."

After alluding to studies that have shown that political connections are important in "countries with high levels of corruption and weak legal systems", the paper examines whether political connections impact firm value in the US and find that political ties do matter.

How do they show this? In their own words
"the paper employs a unique definition of a companyÂ’s political connectedness based on new hand-collected data, detailing the former political positions held by each of the board members of all companies that are in the S&P500 during the year 2000. Information about the political background of board members is then used to sort companies into those that are more connected to the Democrats and those that are more connected to the Republicans."
The closeness of the 2000 presidential election provides an interesting test case since the results were unknown leading up to (and even after) the election.

Their main finding:
"The first main result is that a portfolio of S&P500 companies classified as having a
Republican board significantly outperforms in the post-election period a portfolio of S&P500 companies classified as having a Democrat board. This is true regardless of whether the portfolios are formed based on equal weighting or value weighting....Conversely, the Democrat portfolio exhibits a negative CAR following the election."
As a robustness check, the authors also examine donations to political parties. This data set yields some fascinating factoids. For instance:
"Most of the sample companies donate to both parties, but the relative shares vary substantially. Only 18 of the 315 sample companies donate to only one of the two major parties. The sample companies donate on average $779,985. The maximum donation made by one of the sample companies is $5,075,311...."
The findings using this donation data again support the view that political connections do matter:
"Companies with the highest donations to the Republicans experience on average more than a 3% increase in their stock price over the first seven days after the Election Day. In contrast, stock prices for companies with more donations to the Democrats decrease over the same period of time in the value-weighted average and tend to decrease in the equally-weighted average."
Still not convinced? The authors provide one more piece of evidence. They look at the stock response when a new board member with political connections is nominated to the board of directors. Their finding? Stock prices jump. This CAR is particularly significant for their value weighted portfolios which again suggests that political ties do matter and are especially pronounced for larger firms.

Which deserves a WOW!

As for what it says of the political and legal systems in the US, I will leave that for smarter people to interpret.

I^3 definitely worth reading!

Cite: Goldman, Eitan, Rocholl, Jorg and So, Jongil, "Does Political Connectedness Affect Firm Value?" (July 21, 2006). AFA 2007 Chicago Meetings Paper Available at SSRN: http://ssrn.com/abstract=891426

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