It pays to get a politician on board |
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| Tuesday, 27 May 2008 | |
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A new study reveals a direct impact on share price of companies’ political affiliations.
The research, by the European School of Management and Technology (ESMT), finds that companies with board connections to a winning political party enjoy a significant bounce in share price following an election. Share prices also soar in the wake of an appointment to the board of a politically connected individual. The research is based on comprehensive share price analysis of the S&P 500 immediately following the US presidential election in 2000. Positive and significant cumulative abnormal return The US market was chosen on the basis of its strong financial and regulatory framework, and is the first study of its kind to establish a connection of this sort outside of developing nations more vulnerable to corruption. In view of the quality of the US system, the study concludes that a similar relationship of this sort is likely to exist across the world’s major markets. The study finds that in the seven days following the US presidential election in 2000, companies with board connections to the winning Republican Party exhibited a positive and significant cumulative abnormal return (CAR). This translates into nearly a 3 per cent increase in share price and is true whether each company is given an equal weighting, or weighted based on its market capitalisation. The research defines a company as Republican or Democrat if it has at least one board member with a former affiliation to a particular party, and no such member with ties to the other side. Connection between the politican sphere and the City Meanwhile, when weighted by market capitalisation, Democrat-affiliated businesses found their share prices hit correspondingly hard by the Republican victory, experiencing a negative CAR of almost 3 per cent. When no weighting is applied, the negative impact across Democratic companies in the S&P 500 was insignificant, demonstrating a more pronounced effect on larger companies – despite the greater share price stability that size tends to imply. Professor Jörg Rocholl, associate professor at ESMT and an author of the study along with Eitan Goldman and Jongil So, says that the study brings home the connection between the political sphere and the City, and helps account for some of the value that is perceived in major Western political appointments. He points out that whilst the US enjoys a lot of fluidity between politics and business – the “Statesmen on Call” – we do see appointments closer to home, such as Tony Blair at JP Morgan, his former special envoy to the Middle East and Africa Baroness Symons at British Airways and former health secretary Patricia Hewitt at BT. Whilst there have always been anecdotal reports about the effect political connections have for companies, this is the first time a relationship of this sort has been categorically proved. Market opportunity Professor Rochell explains that this reflects the wealth of opportunity that a politically connected individual can bring to the table, from opening doors for government contracts, to courting business overseas, to lobbying for tax incentives or tariffs on the competition. “For investors, this study also gives them an insight into how a company’s performance may exhibit abnormal returns in the post-election period. For those that partake in investing, short-selling, or price-arbitrage strategies, this poses a significant market opportunity,” he adds. ESMT’s analysis of the 2000 US presidential election results is a particularly strong test case because of the marginal, highly uncertain Republican victory. The result was only finally declared on 13 December 2000 following the Federal Court’s decision to halt the manual recount of votes in Florida. This means that the market did not have the chance to anticipate a result in the run-up to the Republican win. Rigorous series of robustness tests This level of political uncertainty is reflected in the share price movements around two significant calendar events: firstly, 8 December 2000, when the Florida Supreme Court ordered a state-wide recount of ballots in counties with under-votes - increasing the chance of a Democrat victory - and, secondly, 13 December 2000, when Gore accepted Bush as President. In the value-weighted model on 8 December 2000, Democrat companies enjoyed a positive stock return of 1.45 per cent. Meanwhile, the respective Republican portfolio saw a negative return of -1.26 per cent. By contrast, when the Republican victory was declared only 5 days later, the return for the Republican portfolio on 13 December 2000 amounted to 0.32 per cent, while the negative return for the Democratic portfolio was -1.63 per cent. The study subjects the data to a rigorous series of robustness tests in order to control for outside effects that might otherwise account for share price movement. These include controlling for the political preferences of a particular industry (industry-adjusted returns), the location of company headquarters, and the impact of party donations. Consistent positive return On the basis of ESMT’s findings, what would this relationship mean were the UK to see a change in power, or for corporate America in the forthcoming US elections? In spite of the consequences in post-election periods, the study separately finds that it is not all bad news for those companies connected to the Opposition. In normal conditions, having a board member with political connections to any party is in itself a good thing, regardless of which party is in power. Analysing the political connections of board members in S&P 500 companies between 1981 and 2005, the research finds that companies consistently experience a more positive return when politically connected individuals are nominated to the board, irrespective of whether they have relevant expertise in that field. Through the study’s robust economic modelling, the quality and expertise of a given appointment to the board is accounted for, as is the impact of announcing any new board member irrespective of their background. The causal relationship between political connections and share price is again more pronounced where value-weighted controls are applied, suggesting that larger companies are more affected by the political connections of their board. Stock market expectations Professor Rocholl explains that this study proves that any party political connection initiated at any point in time results on average in a positive return for a business, based on the market’s anticipation of the future benefits political connections bring. He points out that these findings suggest a new way in which businesses can increase their value for shareholders, beyond the expertise their directors bring to the table in their advising and monitoring of management. In the eyes of the market, the board can directly create value, purely by the political sway it enjoys and the doors this may open for the business. “The big question now is how much of this impact is about stock market expectations, and how much is borne out in reality in the long run? Considering the extent of the relationship between politically connected boards and share prices, it becomes crucial that government better understands what really is at play,” Professor Rocholl says. He warns that questions of an altogether more serious nature beg to be asked if politically connected boards were to result in companies gaining a significant number of lucrative government contracts. The authors of the research are currently undertaking a second study to explore whether political connections lead to genuine market advantages, such as in the allocation of government contracts. Related articles
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