The Golden Revolving Door

Summary

In the dynamic landscape of today’s interconnected global economy, geopolitical disruptions can send shockwaves along global supply chains through international trade. While many firms struggle to navigate these turbulent waters, some manage to sail smoothly—and even thrive. The secret? Our latest research discovers that government connections, especially those established by recruiting ex-government employees, play an important role in hedging geopolitical risks. Our research paper (Cen, Cohen, Wu, & Zhang, 2023) explores how firms with strong government connections leverage these relationships to gain a strategic advantage during major trade disruptions such as the US-China trade war and the Russia-Ukraine conflict. By uncovering the economic mechanisms underpinning this phenomenon, we provide insights for the value of human capital investment in government connections under geopolitical uncertainties.

The Hidden Power of Government Connections: A Case Study of Honeywell International Inc.

Honeywell, a global powerhouse headquartered in Charlotte, North Carolina, strategically centers its operations on critical sectors such as aerospace, building technologies, performance materials, along with safety and productivity solutions. Over our sample period from 2016 to 2019, Honeywell was a long-term US government supplier that actively engaged in importing from China. After the outbreak of the US-China Trade War, a period marked by widespread reductions in Chinese imports across US industries, Honeywell’s imports from China increased substantially in terms of both the number of transactions and the product quantity. This surprising pattern can be partially attributed to its impressive approval rate for tariff exemption applications during the trade war—24% compared to an average of 12.9% for all applicants (nearly double). A pivotal factor contributing to Honeywell’s success in tariff exemption applications could lie in its strategic recruitment practices, notably targeting former government contracting officers with specialized expertise in government procurement processes.

Generalizing This Surprising Pattern: US Government Suppliers Increased Imports from China in the US-China Trade War

The case of Honeywell epitomizes a broader trend for connected government suppliers. While most US companies reduced their imports from China and sought substitutes in domestic and other markets, US government suppliers, distinguished by their long-term contractual relationships with federal government agencies, in sharp contrast managed to expand their sourcing activities from China after the outbreak of the US-China trade war. This pattern is generalizable, i.e., we observe a similar relative pattern for the imports from Russia during the Russia-Ukraine conflict.

From a capital market perspective, our research shows that government suppliers experience a higher level of cumulative abnormal returns than their peers around earnings announcements. This pattern is consistent with the notion that investors do not fully understand the advantages of connected government suppliers under geopolitical disruptions. As a result, investors underreact to the gains of government suppliers during the US-China trade war and are surprised when the announced earnings of government suppliers are higher than expectations.

Economic Mechanisms

Our results suggest that government connections generate strategic advantages for government suppliers primarily in two ways. First, connected government suppliers are favored when the government exercises discretion in selective or competitive resource allocation (i.e., the “favor” mechanism). We identify this mechanism by showing that, for products on the tariff list, government suppliers are significantly more likely to receive tariff exemptions than other firms. This effect is stronger when government suppliers employ ex-government contracting officers.

Second, connected government suppliers, relative to other firms, are able to collect policy-related information more efficiently and interpret it more accurately than their peer firms (i.e., the “information” mechanism). For products that are not on the tariff list, connected government suppliers gain a vital information advantage, avoiding import reductions from China amid policy uncertainties. For instance, if a Chinese product is tariffed during a trade conflict, unconnected firms may cut similar products imported from China as a precaution. In contrast, connected government suppliers may leverage their information access to predict products that will (and will not) undergo tariff changes, sustaining or even increasing their imports from China.

Conclusion

Utilizing two of the largest geopolitical shocks to global trade in recent decades, our study reveals a counterintuitive pattern: while the average firm trading with nations on whom sanctions have been imposed significantly decreases their trade with these jurisdictions, government suppliers significantly increase their trades from these same sanctioned nations, on average. This effect is particularly strong when government suppliers recruit ex-government employees with expertise in government contracting and procurement. We identify two economic mechanisms to explain this surprising pattern. First, connected government suppliers are likely to receive preferential treatment in tariff exemption applications. Second, connected government suppliers possess a superior ability to predict and interpret trade policies amidst geopolitical uncertainties.

Our findings suggest that the human capital of former government employees—their knowledge, expertise, and networks—is critical to the value of the firms that employ them. This value becomes particularly evident during periods of international trade stress and uncertainty. As geopolitical disruptions continue to evolve and pose increasing shocks to firm value, the human capital of these employees serves as a vital hedge, making them invaluable assets and insurance for firms navigating the complexities of global trade.