Campaign Contributions Boost ROI

Businesses Making Political Contributions See Significant Benefits to Return on Equity and Profitability

Most people would likely be unsurprised to learn that research shows a direct connection between U.S. firms that contribute to politicians and the frequency and quality of the access they subsequently have with those politicians. What has been less clear is whether the stakeholders in those organizations actually do benefit from companies shelling out large amounts of money each year to a constellation of candidates.

This is an intriguing question that has captivated scholars and pundits alike and one that a new study by Alexei Ovtchinnikov, assistant professor at the Vanderbilt Owen Graduate School of Management, addresses. This revealing study – entitled “Corporate Political Contributions and Stock Returns” – uncovered a “positive and significant” relationship between contributions and stock returns, as well as increased profitability, as measured by changes in return on equity (ROE) for firms that contribute. The research provides some of the first hard evidence documenting this impact.

“Although we can’t say exactly how (on a firm-by-firm basis) contributions increase a firm’s bottom line, they appear to, and in a very significant manner,” the report stated. “It appears that the contribution effect is due in part to real changes in firm performance.”

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To understand this complex issue, Ovtchinnikov, in collaboration with Michael Cooper of the University of Utah and Huseyin Gulen of Purdue University, used information from the U.S. Federal Election Commission (FEC) to create a database on the contributions of political action committees (PACs) of publicly traded firms to the political campaigns of U.S. House and Senate candidates from 1979 to 2004. In all, the database encompassed approximately 770,000 contributions made by 1,522 firms. Their analysis, the first to draw upon such a rich dataset of political contributions, sought to identify relationships between political contributions and stock returns as well as relationships between contributions and operating performance.

For instance, the research uncovered that stock returns are positively linked to the number of candidates that are backed. The report stated, “Greater returns were realized by firms that support a greater number of candidates which hold office in the same state in which the firm is based.” The “average” firm participating in the political donation process contributed to 73 candidates over the five-year period, with 53 of those candidates going on to win their elections. The “bottom line” outcome? The stocks of companies that contributed to the largest number of candidates realized higher stock returns and performed better than their competitors by as much as six percent a year. Stronger effects were recorded for firms whose contributions were slanted toward Democratic candidates and House candidates.

Overall, the gain from participating in the contributions process translated to an average one-year increase in shareholder wealth across all of the firms analyzed of more than $106 billion, or about $154 million per year per firm.

Relatively Few Firms are Politically Active

Given this significant windfall, one would think companies would be clamoring to outdo one another with political contributions. However, only about ten percent of publicly traded firms are politically active. The report shed light on this mystery, stating, “It appears that firms in certain types of industries choose to participate because they directly benefit more than firms in other industries where the potential welfare gains from political contributions are not as easily attainable.” Among the participating industries are those that sell more of their products to the government (such as defense and aerospace), are more heavily regulated (such as financial services) or have a smaller number of firms in competition. In addition, companies with higher percentages of unionized employees fared better.

There may be another deciding factor as well. The study points out that gaining political leverage can come with a steep price. It elaborated: “The true costs for firms to participate in the political process are greater than (just) the costs of hard-money contributions, and potentially include other off-the-book contributions or non-money favors, for which only large firms can afford to pay.”

Contributions Also Benefit Operating Performance

Having identified the relationship between contributions and stock market returns, the researchers next sought to discover why politically active firms are able to enhance their ROE. Said Ovtchinnikov, “We found a very positive and economically significant relationship between contributions and operating performance.”

What accounts for this relationship between donations and business performance? The report stated, “Potential ways in which politician-sponsored legislation may benefit firms include (but are not limited to) favorable tax treatment and or credits, the awarding of government contracts, the imposition of tariffs or other penalties on competitors, and implementing favorable regulatory requirements.”

In conclusion, Ovtchinnikov acknowledged that the study just scratches the surface of the vast and murky area of corporate campaign contributions. “While the types of political contributions we researched are perfectly legal and well documented by such organizations as the Center for Responsive Politics (www.opensecrets.org), this is an overlooked area and one that is potentially significant for savvy investors,” he said.

“What we have sought to do with our initial research,” according to Ovtchinnikov, “is to raise awareness of this important issue. The next step will be to gain a better understanding of how contributions and politicians intersect to provide value effects for businesses.”

In the meantime, the odds are looking good for a positive return from that corporate political contribution.

Send comments to alexei.ovtchinnikov@owen.vanderbilt.edu

Reported by Scott Addison

Published 4/21/08 in OWENintelligence
© 2008 Vanderbilt Owen Graduate School of Management