Capitol gains: new research shows that firms' political connections directly affect their share prices--even in nations as highly regulated as the US. Jorg Rocholl explains the implications.

AuthorRocholl, Jorg

As Barack Obama and John McCain fight the final rounds of their battle for the Oval Office, there is growing interest in what the victor's policies will mean for the US and the rest of the world. What we may not have considered yet is the impact that the new government might have on the nation's companies and those who invest in them.

Most people will probably have heard an anecdote or two about politically connected board members and rumours regarding the benefits they bring to their companies. These might include opening doors for government contracts, courting business partners overseas, lobbying for tax incentives or pushing for tariffs on competing companies. We all know that this is a real concern in countries where regulation is weak and the risk of corruption is high. But what about more regulated nations? Could such an effect be significant, despite the net of regulation and the media scrutiny that comes with economic development?

Bearing in mind the significant number of companies in the US and UK that have former politicians on their boards--the most prominent example being Tony Blair, who serves US investment bank JP Morgan in a "senior advisory role"--this question is more than academic. And the answer could be hugely valuable to investors.

Research conducted at the European School of Management and Technology, Indiana University and the University of South Carolina has found that, even in developed countries with strong regulatory and financial frameworks, having politically connected board members has a significant effect on the share price of the business in question. We examined the share prices of S&P 500 companies after the 2000 US general election, sorting them into three categories according to the affiliations of their board members: Republican companies, Democratic companies and those with no definitive political connection.

A company was defined as Republican or Democratic if, at the time of the election, its board contained at least one member with close connections to one or other political party--eg, they had served as a senator or member of the House of Representatives--and no one with connections to the other side. In the days immediately after the Republicans' victory was announced, firms connected to that party consistently and significantly outperformed those with Democratic affiliations.

Republican companies experienced a positive cumulative abnormal return (CAR) of nearly three per cent in share price after...

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