Business case for lobbying and the SOX-Enron of 1720..

Businesses lobbying government has always seemed a bit odd to me. Is there a link between all that talking to politicians and company success? Well, one of my research feeds from SSRN picked up two fascinating papers that are well worth a read, but here are the abstracts and a couple of quotes if you are too busy for academic papers.

One, by Goldman, Rocholl and So, from the University of North Carolina.  

In countries with a weak legal system and a high level of corruption it may not be surprising to find that political connectedness is valuable to a corporation. This paper explores whether political connectedness is also important in the U.S., which has the most developed financial markets in the world as well as a very strong legal system. The paper uses an original data set on the political connections of board members of S&P500 companies to sort companies into those connected to the Republican Party and those connected to the Democratic Party. An analysis of the stock price response of these companies to the Republican win in the 2000 Presidential Election finds that companies connected to the Republican Party increase in value while companies connected to the Democratic Party decrease in value. In addition, the paper finds that the announcement of the nomination to the board of politically connected directors results in a positive abnormal stock return. The analysis further suggests that the above effects are more pronounced for the larger corporations. Finally, using an additional (indirect) measure of political connectedness based on political contributions by corporations prior to the 2000 election lends further support to these results. 

If you need a business case for lobbying and having an old politician on your board, I guess this is it. Silly me, thinking that share prices were a reflection of future discounted cash flows. As the paper notes,

First, following the announcement of the Republican win, the return difference between companies classified as having a Republican board and those classified as having a Democratic board is positive. Furthermore, the announcement returns are positive for the Republican portfolio and negative for the Democratic portfolio. These results are reconfirmed when using an alternative definition of connectedness based on political contributions and in addition they remain robust after controlling for several firm characteristics as well as for industry effects.

Secondly, following the announcement of the nomination to the board of a politically connected individual, there is on average a positive and significant stock price response.

The second paper (a lecture) by Painter from the University of Minnesota goes back a bit further and looks two major bits of financial history, the South Sea Bubble and the the US National Bank saga.

 This lecture addresses a phenomenon that arises repeatedly in history: concurrent and interrelated corruption in the political system and in business that puts political and business establishments on the defensive. When corruption from business spills over into government, the story is likely to end with politicians seeking to cover for their own actions or to elevate themselves on an ethical pedestal above their peers. Resulting legislative action – hostile to business and driven by self serving political considerations in the wake of scandal – is often not well thought out, and may hinder economic growth and stability.

The lecture discusses two examples of this phenomenon in England and the United States respectively. First, the South Sea Bubble of 1720 – during which many Members of Parliament took bribes in South Sea Company stock and traded in the stock on inside information – was followed by Parliament’s draconian restriction in the Bubble Act on transferability of shares for over 100 years thereafter. Second, there were two attempts at the end of the Eighteenth and the first half of the Nineteenth Century to establish a permanent Bank of the United States modeled on the Bank of England. This undertaking was championed by Federalist and Whig politicians who, while they may have sought economic stability, also encouraged speculation in government securities on inside information, and bribery by the Bank of Members of Congress. The debate over the Bank was in part a debate over corruption that came with it. The First Bank of the United States was opposed and eventually allowed to expire by Jeffersonian Democrats and the Second Bank was attacked, and then pushed out of business, by President Jackson. Congress failed to establish a national bank until the Wilson Administration in 1913, two and a quarter centuries after establishment of the Bank of England.

The lecture concludes that corruption of government by business is not only bad for government, but in the long run bad for business. Business sometimes overreaches in  influencing government officials, but at the risk of a backlash in which politicians – in self righteous indignation or in order to cover up for their own actions – embrace harsh anti-business policies, regardless of whether those policies are in the national economic interest.

Pointer goes on to note in the lecture. (excuse the long quote)

Modern parallels do come to mind. Some might think of Enron, Worldcom and the Sarbanes-Oxley Act. As a current White House employee, I will not say more about these scandals beyond what I said before I entered government service. I reviewed former SEC Chairman Arthur Levitt’s book in 2003.While I disagreed with some of Levitt’s substantive views on securities law, I shared his concern that accounting firms – including Arthur Anderson while it audited Enron’s books — undermined the SEC’s independence by making an end run to Congress to complain about proposed SEC rules. Levitt pointed out that campaign contributions were a significant part of the strategy

Enron and Worldcom embarrassed government and business. There is considerable speculation about whether Congress overreacted. If so, the Enron/Worldcom fiasco would fit into the broader phenomenon I discuss in today. Harsh legislative action follows political backlash when business exerts excessive influence on government. Legislative action taken in an atmosphere of moral indignation does not necessarily rid the political system or the economy of corruption, but may leave a body of corporate law, or a banking system, or a capital market that is weaker than what existed before.

I could quote the whole paper but go and download it from SSRN instead. It is probably the most interesting thing about SOX you will read.

I’ll almost finish with a poem from Alexander Pope

At length corruption, like a general flood,
Did deluge all, and avarice creeping on,
Spread, like a low-born mist, and hid the sun.
Statesmen and patriots plied alike the stocks,
Peeress and butler shared alike the box;
And judges jobbed, and bishops bit the town,
And mighty dukes packed cards for half-a-crown:
Britain was sunk in lucre’s sordid charms. 

And I’ll finish with a quote from Marx.

Hegel remarks somewhere that all great world-historic facts and personages appear, so to speak, twice. He forgot to add: the first time as tragedy, the second time as farce.

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