Corporate Distress and Lobbying: Evidence from the Stimulus Act

The following post comes to us from Manuel Adelino of the Finance Area at Duke University, and Serdar Dinc of the Department of Finance and Economics at Rutgers University.

In our paper, Corporate Distress and Lobbying: Evidence from the Stimulus Act, forthcoming in the Journal of Financial Economics, we contribute to the long literature on corporate behavior in distress, as well as to studies of the consequences of financial distress. Using the financial crisis in 2008 as a negative shock to nonfinancial firms’ financial conditions, we document a novel fact on the relation between firms’ financial health and their lobbying activities. We compare the lobbying activities of firms before and after the onset of the crisis and find that firms with weak financial health—as measured by their CDS spread—lobby more. This result is robust to controlling for such firm-specific variables as size, profitability, and market-to-book ratio, all the firm characteristics that remain unchanged during the short window before and during the passage of the stimulus act, sector-wide time trends, and the adoption of different time windows for comparison in the difference-in-differences framework.

Interestingly, weaker firms decrease their capital investments in this period while increasing their spending for lobbying, which suggests a shift from productive activities to rent seeking, as discussed in Murphy, Shleifer, and Vishny (1991, 1993). Such shifts to rent seeking are costly to the economy, but much of those costs are incurred by the whole economy rather than by particular rent-seeking firms. Hence, estimates of financial distress costs in the corporate finance literature are unlikely to fully capture the costs of rent seeking attributable to the deteriorating financial health of firms.

These lobbying activities seem to be fruitful for the firms. We find that firms spending larger sums for lobbying were subsequently more likely to be a direct recipient of stimulus funds and to receive a larger dollar amount under the bill. Interestingly, this is not a reflection of firm financial health. When we control for the total amount spent for lobbying, firm financial health has no effect on the disbursement of stimulus funds. In other words, firms that lobbied, not firms that were financially weak per se, were more likely to receive stimulus funds.

It has been argued that it is the richer constituencies who have access to government and who are able to make their voices heard (Esteban and Ray, 2006; Morck, Stangeland and Yeung, 2000). We argue in this paper that the effect of financial strength on lobbying efforts is more nuanced than previously thought and that the direct effect of financial strength on lobbying for large US firms is, in fact, negative—that is, firms increase spending on lobbying when they become weaker, not when they get stronger.

The existing work on firm behavior in distress has highlighted the types of investments made by these firms, as well as consequences for management from distress. We show that firms often attempt to escape a deteriorating financial condition by attempting to influence government in their favor. This paints a more complete picture of firms, as it shows that they consider many alternative levers to improve their condition when under stress.

This paper focuses on lobbying, but firms may also use other political activities in response to financial distress. For example, they may seek to appoint politically connected directors. As discussed by Faccio, Masulis, and McConnell (2006) and Goldman, Rocholl, and So (2009, 2013), such connections may facilitate corporate rescues by the government or the favorable allocation of government procurement contracts. These firms may also increase their campaign contributions. Whether corporate political activities other than lobbying also increase upon deterioration in corporate financial health is a fruitful area for future research.

One additional issue we are not able to deal with given the current data is the total return to lobbying activities. It is interesting to note that, although lobbying expenses are an order of magnitude larger than the political contributions of corporate PACs, they are still small relative to average corporate earnings or assets. If indeed lobbying affects the probability of obtaining government contracts or legislation that directly concerns these large firms, the potential benefits of lobbying can be very large. However, a simple comparison of lobbying expenditures disclosed and the stimulus funds received not only suffers from omitted variables problems but may also be misleading, because many lobbying activities require, for example, the personal involvement of top management. Hence, any calculation of returns to lobbying that does not incorporate the opportunity cost of lobbying may overstate the true returns to lobbying activities.

The full paper is available for download here.

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