Political connectedness and stock returns: The return implications of coincidental direct and indirect political connectedness

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Volume Title

School of Business | Master's thesis

Authors

Date

2018

Department

Rahoituksen laitos

Major/Subject

Mcode

Degree programme

Finance

Language

en

Pages

49

Series

Abstract

I study the joint effect of direct and indirect political connectedness on public U.S. firms’ stock returns and find evidence that indirect connectedness may amplify the positive effect of direct connectedness. Using the political alignment index (PAI) from Kim, Pantzalis, and Park (2012) to measure indirect political connectedness, and political contribution measures from Cooper, Gulen, and Ovtchinnikov (2010) to measure direct political connectedness, my results indicate that the positive effect of political contributions on both annual abnormal returns and annual excess returns is stronger for firms that are headquartered in a state led by politicians closely aligned with the presidential party. In addition to discovering the joint effect, I examine firms’ contribution behavior around varying levels of indirect political connectedness and find that the firms that increase dona-tions more than their average peer does outperform firms with smaller-than-average increas-es when the state’s political alignment changes to high or medium level, but not when it changes to low level. There are several plausible explanations for the positive return effect of direct and indirect political connection, and the discovered joint effect. The most intuitive explanation is to argue that direct connectedness either benefits firms as it increases the probability of getting the supported candidates elected (see, e.g., Bronars and Lott, 1997) or because supported legisla-tors make decisions that are favorable to the supporting firm (see, e.g., Welch, 1980; Strat-mann, 1998 and 2002), and that the resulting benefits are magnified by indirect political con-nectedness. However, as a supplemental explanation, I discuss the possibility that direct connectedness benefits firms through the aforementioned connectedness advantages, but indirect connect-edness increases firms’ policy risk (Kim, Pantzalis, and Park, 2012). If this is the case, based on the results presented in this paper, it seems possible that political connectedness has an additional risk-decreasing influence that is stronger for firms with high policy risk, which would explain the joint effect that direct connectedness seems to be more beneficial for firms with high indirect political connectedness. Since giving a definitive explanation for the aforementioned effects is not plausible based on the existing literature nor the dataset used in this study, I also discuss several other potential explanations along with limitations that may have a role in explaining the joint effect. This paper contributes to existing literature by being, to the best of my knowledge, the first to study and document the joint effect between indirect and direct political connectedness on firm’s stock performance. Furthermore, the results and the analysis in this paper contribute to the discussion on the explanations for the return implications of both indirect and direct polit-ical connectedness, and the newly discovered joint effect.

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Thesis advisor

Nyberg, Peter

Keywords

Political Contributions, Policy Risk, Political Geography, Returns, Performance

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Permanent link to this item

https://urn.fi/URN:NBN:fi:aalto-201811195815

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[gradu] Kauppakorkeakoulu / BIZ