Is the Revolving Door of Washington a Back Door to Excess Corporate Returns? via SSRN

Mehmet Ihsan Canayaz

University of Oxford – Said Business School

Jose Vicente Martinez

University of Connecticut

Han N. Ozsoylev

Koc University – College of Administrative Sciences and Economics; University of Oxford – Said Business School

April 20, 2015

Abstract:

In this paper, we look into the so-called “revolving door of Washington”, which is the movement of individuals between federal government positions and jobs in the private sector, and examine its link to long-run stock returns. We find that firms where current public officials become future employees outperform other firms by a statistically significant 7.43% per year in terms of four-factor alpha. This result is robust to different weighting methodologies and risk adjustments, and to plausible reverse causality arguments. We also show that firms receive more valuable government contracts from a government agency when a future firm employee is holding a post at that agency. Such financial gains are significantly reduced during periods in which presidential executive orders restrict revolving door movements. Our results are consistent with the notion that some public officials could be favoring certain companies while in office with a view to gaining future corporate employment.

Is The Revolving Door Of Washington A Back Door To Excess Corporate Returns? – Introduction

In a July 2007 campaign appearance in Manchester, N.H., then-presidential candidate Barack Obama said, \When I am president, I will make it absolutely clear that working in an Obama administration is not about serving your former employer, your future employer, or your bank account. It’s about serving your country, and that’s what comes first.” Obama also stated that, for two years, employees would be prohibited from working on regulations or contracts directly related to their previous employers. That ban, he said, would close a \revolving door” for former and future employers.

Obama’s campaign remarks reflected the public unease with the movement of individuals between government positions and jobs in the private sector. Several revolving door movements had aroused public ire in the U.S. The poster child example for the conflicts of interest created by these movements was Darleen Druyun. Druyun, who oversaw the management of the Air Force’s weapons acquisitions program, joined Boeing in 2003 as the Deputy General Manager for Missile Defense Systems. Subsequent disclosures revealed that she was negotiating the terms of her Boeing employment while she was handling a proposal to lease tankers from Boeing. The proposal was more costly than purchasing the tankers outright.

It is no surprise that many on the street hold the view that revolving door movements are potentially corrupt activities and favor restrictions on such movements. However, there are others who argue that unduly restrictive provisions on revolving door movements may deter qualified and competent people from joining government service. Unfortunately, there is limited empirical evidence on how revolving door movements impact corporate employers’ performance and their business with government. Such evidence would allow for more objective and informed assessment of policy prescriptions regarding this issue. It would also contribute to the broader economic debate on effective regulatory design { a debate that goes back to at least Pigou (1938).

This paper contributes to filling the evidence gap on the conflicts of interest generated by revolving door movements by investigating their impact on corporate financial and operating performance. The conflicts of interest we study include: (i) Conflicts prior to corporate employment: Public officials may abuse their power while in office to favor a certain company or industry, with a view to ingratiating themselves and gaining future employment. (ii) Conflicts during corporate employment: Former public officials, who switch to the private sector, may influence their former government colleagues to make decisions in a way that favors their new employers. Also, they may use confidential information to benefit their new private employers { for example during procurement procedures. (iii) Conflicts after corporate employment: Public officials may allow the agenda of their previous corporate employer to influence their government work.

We obtain data on revolving door movements from the Center for Responsive Politics’ (CRP) Revolving Door Database. With these data in hand, we first investigate whether revolvers add shareholder value to their future corporate employers during their government tenure prior to corporate employment. We find that firms where current public officials are to become future employees outperform other firms by a statistically significant 7.43% per year, on an equally-weighted basis, during the three years before the officials join them.

The outperformance, measured using the Fama-French-Carhart (1997) four-factor model, is at its strongest immediately before the hiring of the revolver, and diminishes and eventually vanishes as we move further away from the hiring date. The outperformance is also stronger for firms that hire a larger number of revolvers, relative to their size.

Revolving Door Of Washington

Revolving Door Of Washington

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