Political Values, Culture, and Corporate Litigation

Danling Jiang is Associate Professor of Finance at Florida State University. This post is based on an article authored by Professor Jiang; Irena Hutton, Associate Professor of Finance at Florida State University; and Alok Kumar, Professor of Finance at the University of Miami.

In our paper, Political Values, Culture, and Corporate Litigation, published in the latest issue of Management Science, we examine whether the political culture of a firm defines its ethical and legal boundaries as observed by the propensity for corporate misconduct. Using one of the largest samples of litigation data to date, we show that firms with Republican culture are more likely to be the subject of civil rights, labor, and environmental litigation than Democratic firms, consistent with the Democratic ideology that emphasizes equal rights, labor rights, and environmental protection. However, firms with Democratic culture are more likely to be the subject of litigation related to securities fraud and intellectual property rights violations than Republican firms whose Party ideology stresses self-reliance, property rights, market discipline, and limited government regulation.

We quantify the political culture of a firm using a composite index (Political Culture Index, or PCI) that is based on the political leanings of the firm’s top managers, including its CEO, Political Action Committees (PACs), and local residents. We measure the political leanings using monetary contributions of individuals or PACs to various political campaigns. Thus, our composite political culture index captures the political attitudes of a firm’s employees across its organizational hierarchy, its shareholders, monitors, as well as other community stakeholders.

To measure the propensity of corporate misconduct, we use a comprehensive sample of litigation filings associated with employment civil rights, labor, environmental, securities, and intellectual property violations filed during the 1993 to 2007 period and terminated by the end of 2008. The final litigation sample contains 31,343 civil rights lawsuits, 3,449 labor lawsuits, 960 environmental lawsuits, 2,927 securities lawsuits, and 5,050 intellectual property lawsuits, all filed in the Federal district courts, which to our knowledge constitutes one of the most comprehensive litigation datasets.

Our main empirical tests focus on the relation between PCI and the propensity of a firm being the subject of a certain type of litigation in a given year. Our estimates indicate that compared to firms with a Democratic culture, Republican firms are 13.5%, 3.5%, and 0.5% more likely to be sued for employment civil rights, labor rights, and environmental regulation violations, but 1.5% and 4.0% less likely to be sued for securities violations and intellectual property violations, respectively. These effects are significant economically considering that the unconditional probabilities of these corporate events are 35.2%, 8.8%, 3.1%, 4.0%, and 12.9%, respectively. Similar results are obtained when we use measures of litigation severity such as the annual number of lawsuit filings or the proportion of lost and settled lawsuits.

Our findings are also robust to alternative measures of political culture based on the number of candidates supported and the inclusion of a large number of firm and industry and state characteristics as well as time fixed effects. In particular, as the nature of business can affect the lawsuit propensity, we control for the industry-level litigation volume. Further, we find that weak firm governance and option-heavy executive compensation, the two common explanations of corporate wrongdoing cannot fully explain our results although political culture tends to have a stronger effect on litigation propensity in firms with weak governance. The main challenge to these traditional theories is to explain why corporate governance or executive compensation would differentially induce misconduct in some settings and deter it in other settings.

A potential explanation for our findings is that political contributions are endogenously determined by the fundamental nature of the firm’s business that is not fully captured by the industry and firm controls. To establish a causal relation between political culture and the propensity of misconduct, we use a home state attribute (educational attainment or gun ownership) measured in early 1990s as an instrumental variable. Each of the instrumental variables is strongly correlated with PCI and helps to address reverse causality concerns since business needs or resulting litigation propensities of a firm are unlikely to alter the characteristics of the entire state. For both instruments, we find that the instrumented PCI continues to have a significant impact on litigation propensities in value-relevant domains.

In the last part of the paper, we study the market reactions to corporate litigation filings as measures of expected litigation costs. After controlling for a set of firm and industry characteristics and proxies for observed litigation severity, we find that investors react more negatively to the filings of securities and environmental litigation in Republican firms, while there is no statistically significant difference following litigation filings related to civil rights, intellectual property rights, or labor violations. These findings suggest that expected litigation costs do not help explain why relative to firms with Republican culture, firms with Democratic culture are more likely to engage in securities fraud or violate intellectual property rights but less likely to violate civil rights, labor rights, or environmental protection regulations. Thus, the observed litigation propensity is likely to result from culture-driven, as opposed to cost-driven, firm decisions.

In summary, our results establish an economically meaningful link between political culture and corporate wrongdoing. One important implication of this finding is that a firm’s political culture can serve as an “internal” monitoring system that guards certain interests of shareholders and the broader community. Interestingly, unlike other cultural attributes such as religion, language, and ethnic heritage, political values do not have a uniform impact on all corporate decisions. In future work, it may be useful to examine how multiple dimensions of firm culture jointly affect corporate misbehavior.

The full paper is available for download here.

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