Institutional Investors And Corporate Political Activism
University of Surrey – Finance and Accounting Group
ESMT European School of Management and Technology
University of Warwick – Finance Group
May 18, 2016
The landmark decision by the U.S. Supreme Court on Citizens United v. Federal Election Commission asserts for the first time that corporations benefit from First Amendment protection regarding freedom of speech in the form of independent political expenditures, thus creating a new avenue for political activism. This paper studies how corporations adjusted their political activism in response to this ruling. The paper presents evidence consistent with the hypothesis that institutional investors, in particular public pension funds, have a preference for not using the new avenue for political activism, a preference not shared by other investors.
Institutional Investors And Corporate Political Activism – Introduction
Adam Smith (1776) postulates utmost care when dealing with political demands by capital-owners, as their self-interest may significantly deviate from public interest. Capital-owners today are not restricted to businesses such as merchants and master manufacturers. Rather, states have amassed significant amounts of capital and control of business through state pension funds. This raises the important question of whether the actions taken by states as capital-owners have to be considered with the same care as those taken by businesses.
The U.S. Supreme Court’s landmark decision on Citizens United v. Federal Election Commission in January 2010 provides a unique opportunity to investigate the important question of a potential agency conflict in U.S. public pension funds. The decision asserts for the first time that corporations benefit from First Amendment protection regarding freedom of speech in the form of independent political expenditures. The ruling generated significant controversy and resulted in a seven-fold increase in independent expenditures to federal elections. President Barack Obama (2010) voiced the opinion of many regarding Citizens United in his State of the Union Address: “Last week, the Supreme Court reversed a century of law that I believe will open the floodgates for special interests – including foreign corporations – to spend without limit in our elections. Well I don’t think American elections should be bankrolled by America’s most powerful interests …” The Council of Institutional Investors (CII) and the Center for Political Accountability (CPA) urged S&P 500 companies in a letter to adopt rules to disclose all corporate political contributions and called on boards to review and approve such contributions (CPA-CII, 2010).
Citizens United represents the most dramatic change in corporate campaign financing since the Taft-Hartley Act of 1947 that prohibited corporations from making any expenditure in connection to federal elections. It thus provides a unique experiment to study how corporations with different ownership structures adjust their inputs to political activism. Corporations are not new to political activism and have used political connections, lobbying, and contributions by executives and Political Action Committees (PAC). We revisit and broaden Adam Smith’s concern by noting that public pension funds are agencies of state governments that could pursue political agendas outside the scope of public corporations, see e.g. Romano (1993), Mitchell and Hsin (1997).5 This creates a potential conflict of interest between public pension funds and other shareholders (see e.g. Woidtke, 2002, and Coronado, Engen, and Knight, 2003) and raises the important question of whether the market response to Citizens United depends on having institutional investors who may be engaged in political activism themselves.
Using a sample of 1,722 firm-year observations, we find that the average three-day return on the announcement of Citizens United amounts to 0.92%. In the cross-section, firms with more political connections exhibit lower three-day abnormal stock returns than firms with less political connections. This negative effect is concentrated on firms with high institutional ownership, whereas we find a positive market reaction for the firms with no institutional ownership. A one-standard-deviation increase in the number of political connections leads to a 1.20% lower three-day abnormal return for firms with high institutional ownership than for firms with zero institutional ownership, a relative loss of $83 million in market capitalization. This result is consistent with a general inability of high institutional ownership firms with established political connections to adjust to the presence of a new input to political activism. In contrast, we do not find any significant stock market reaction for lobbying, PAC spending, or executive contributions. This could be because lobbying activities encompass the provision of issue-specific information (Bertrand, Bombardini, and Trebbi, 2014) and therefore may bring unique value to political activism;6 PAC contributions come from employees (and shareholders) and are thus not at the full discretion of management; executive contributions have low legal limits. In contrast, political connections, like independent political expenditures, are exclusively about political activism and are strictly under the control of the management, thus being a closer substitute.
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