The Cost of Political Connections

Antoinette Schoar is the Michael M. Koerner Professor of Entrepreneurship at the MIT Sloan School of Management. This post is based on a recent article, forthcoming in the Review of Finance, by Professor Schoar; Marianne Bertrand, Chris P. Dialynas Distinguished Service Professor of Economics at the University of Chicago Booth School of Business; Francis Kramarz, Associate Professor at Ecole Polytechnique; and David Thesmar, Franco Modigliani Professor of Financial Economics at the MIT Sloan School of Management.

A large literature in corporate governance has analyzed the nexus between politics and business to show that politically connected firms can benefit from connections, for example, by receiving preferential access to government resources or favorable regulations, see Fisman (2001) or Morck and Yeung (2003). In this article, we explore a potential downside for a firm of having a politically connected CEO: Connections might lead CEOs to use firm resources to help incumbent politicians stay in power even if it is not beneficial for the firm, since it might advance their own careers or personal interests. We use France as our research setting since a large fraction of publicly-traded assets are managed by CEOs whose past professional experience involved serving in government.

The particular distortions we analyze are corporate hiring and firing decisions. We test whether connected CEOs maintain employment levels that are above the economically efficient level in order to grant election favors to connected politicians. Prior work has shown that employment conditions are of great importance to voters when deciding whether to re-elect an incumbent politician (see, for example, Wolfers, 2002). Using detailed firm and plant level data from France, over the 1987 to 2002 period, we first show that business and political elites have strongly overlapping networks and many politicians move to private sector firms after they leave politics. 11 percent of all CEOs in our sample had some prior work experience in the French civil service. These ex-civil servants control more than 60% of publicly-traded assets. We find that politically connected firms use employment as a lever to help politicians. We show that the connected firms do not seem to benefit significantly from being politically connected.

Our key empirical strategy is to compare hiring and firing patterns at publicly-traded firms that are managed by politically connected CEOs versus firms whose CEOs are not connected. To identify whether connected CEOs are more likely to grant election favors to incumbent politicians, we test whether there are significant differences in hiring and firing patterns around election times, or in areas that have more contested and close elections. To attribute any differential growth in job creation or reduced layoffs at the firm level to political motive, our identification strategy uses two important assumptions. A second related assumption is that connected CEOs are more likely to respond to the needs of political incumbents than to the needs of opposition candidates. We find higher employment growth, higher rates of plant creation, and lower rates of plant destruction for firms managed by politically connected CEOs in election years. The effects are especially pronounced if the plants are located in politically contested cities with close elections. Importantly, we show that these employment patterns are robust to controlling for a set of firm characteristics that vary with the political background of the CEO such as firm size and whether the firm was formerly state-owned.

We analyze the nature of the relationship between connected CEOs and politicians. Our proxy for political connections is whether a CEO was previously a cabinet member (i.e., a close advisor to a minister). First, we analyze whether politically motivated favors are stronger when CEOs and politicians are on the same side of the political spectrum. These findings do not support an interpretation where connected CEOs use corporate resources to merely further their ideological causes. Since political favors appear to extend across party lines, the results suggest that these networks proxy more generally for access to government or familiarity with the political process. Second, we ask whether the strength of politically motivated employment favors varies with the political clout, and hence potential influence, of the political incumbent. The results here suggest that mayors with political clout receive more employment favors from connected CEOs. There are, of course, many possible reasons for political clout to translate into larger employment favors.

Second, we show that these election favors do not seem to be part of a two-way gift exchange between politicians and connected CEOs. We focus on two of the main levers that politicians have with regards to firms: subsidies and taxes. We do not find that in response to employment favors firms managed by connected CEOs receive significantly larger local subsidies or tax breaks. In addition, we explore whether politically connected firms outperform unconnected firms in the cross-section. One could imagine that powerful politicians have other, more difficult to measure channels to pay back CEOs who helped their re-election chances. However, we should expect connected firms to have higher performance than unconnected firms if these channels are of first order importance. We do not find evidence to that effect. Specifically, we show that the ROA for connected firms decreases as the fraction of their employment located in politically contested cities increases. In line with our hypothesis above, we also show that the lower return on assets can be related to a higher wage bill for these firms. This may indicate that connected firms have “too many” employees. In sum, it appears that the employment distortions we measure around local election do not seem to lead to any direct benefits for the connected firms. As a result, we conjecture that they are the result of personal rent extraction of the connected CEOs who use firm resources to advance their standing among the political elites.

The complete article is available here.

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