But Kellogg researchers challenged that conventional wisdom in a recent study. While moving up the government ladder gives more power, it also puts politicians under the microscope as the media and other organizations closely monitor their activities for signs of corruption. If the incumbent wants to be re-elected, the harsher spotlight could discourage them from doing favoritism.
“There’s more scrutiny at the highest levels,” he says Kieu-Trang Nguyen, assistant professor of strategy at Kellogg. Although the politician has more power to distribute favors, “this entails greater risk.” And if control is strong enough, the researchers hypothesized, the trend might actually go in the opposite direction: gaining more power could lead to fewer favors.
To test this hypothesis, the researchers analyzed nine years of US congressional elections as well as companies with ties to the winning and losing candidates. The team used companies’ stock prices as an indicator of how much the market expected those companies to receive favors from connected politicians. They found that during election weeks, the average value of firms associated with a winning candidate declined relative to firms associated with a losing candidate.
“On average, it’s a negative effect,” says Nguyen. “Stronger control trumps stronger ability to grant business favors.” The system is “working the way we hope it will.”
Does power corrupt?
Previous studies generally suggested that more political power led to more favoritism.
For example, a 1990 study analyzed the aftermath when Henry Jackson, the minority member of the US Senate Armed Services Committee, died suddenly. The stock price of companies that employ many manufacturing workers in the state of Jackson, Washington, fell. So did the stock prices of the companies that participated in the political action committee (PAC) in the Jackson campaign. The next minority committee member in line, Sam Nunn, was expected to step up to the ranking member position. Share prices of companies with a significant presence in Nunn’s home state of Georgia, as well as PAC contributors there, rose. The market, apparently, expected Nunn to soon do favors for these companies.
“This is a classic example of what people usually expect,” he says Quoc-Anh Dovisiting associate professor at Kellogg.
However, previous research has often been limited to a small set of politicians or has tended to focus on older representatives, who may not be as interested in re-election, Nguyen says. Thus, Nguyen, Do and colleagues, Yen Taek Lee at the National University of Singapore Business School and Bang Nguyen at the University of Cambridge Judge Business School, he took a different approach. They decided to analyze a broad set of American politicians at a critical career transition: entering Congress. Many candidates had held state office, where they were likely able to dish out favors, but would face much more scrutiny when they moved up to the federal level.
Future prospects
The team obtained data on 126 close congressional elections from 2000 to 2008 from the Federal Election Commission. Then, for both top candidates, they gathered biographical information from a variety of sources to determine a candidate’s educational history, with the rationale that former classmates are likely to be part of their network of contacts. The researchers then searched BoardEx data for company directors who had graduated from the same school within a year of one of the candidates. The final data set included 170 politicians connected to 1,171 directors in 1,268 companies.
The team then looked at what happened to each company’s stock price from the day before the election to five days after. They calculated that if the market predicted that the company would receive favorable treatment from the connected politician, the change in the company’s expected future revenue should show up as a change in its stock price.
“The share price should reflect what the market thinks the company will get in the long term – not just next year, but the overall outlook going forward,” says Do.
Not all investors will necessarily be aware of alumni-network links between candidates and companies. However, a small number of investors may closely monitor these companies or have insider knowledge of such political connections. Their trading decisions could influence others to follow suit, amplifying the change in the share price.
The researchers chose to focus on tight races with less than five percent of the vote because the market would not be able to predict the winner before the election. As the results were released, prices would adjust and researchers could detect the change. Conversely, if a candidate was heavily favored to win, the market would have already adjusted stock prices in anticipation, and the changes would not show up during election week.
A Long Horizon
The researchers found that ties to a winning politician actually seemed to suppress the market value of firms. Their average share price movement was 2.8 percentage points lower than that of companies associated with the defeated candidate. Controlling for factors such as the politician’s party affiliation and which party controlled Congress made little difference to the result.
The researchers then looked at whether the politician’s age made a difference. Younger representatives were likely more concerned about their re-election chances than their older counterparts.
“Politicians care about their political careers, so they don’t want to jeopardize that,” says Do. “If they’re younger, they tend to care more about it because the horizon is longer.”
The results confirmed this: the negative effect of an election victory on the share value of a related company was stronger for younger politicians and decreased as they got older.
Under the microscope
The group also assessed the amount of scrutiny politicians had faced at the state level. If a candidate had gone through state politics unsupervised, he probably would have given more grace to this tolerant environment. When they entered federal politics, the increase in attendance would be greater. So affiliated companies would likely see a bigger drop in their share prices, the researchers reasoned.
“Now that the politician is moving to DC, the company can no longer enjoy such favors, so that’s a bigger loss,” Do says.
To see if this theory held true, the team looked at various control measures in each candidate’s state. For example, if voter turnout was high and voters showed strong interest in pre-election news, these were seen as signs of tighter control. The researchers also noted the amount of corruption reported in each state, for example, by determining the number of corruption cases per capita in each state as reported by the Department of Justice. They reckoned that lower levels of corruption meant that politicians were more closely monitored and did not get away with bad behaviour.
In low-scrutiny states, the value of affiliates’ stock declined more when the politician entered Congress than in high-scrutiny states. “We should expect the negative gap to be larger among these states, and that’s what we actually find,” says Nguyen.
Since the study shows that oversight matters, he says, it’s important to increase oversight at lower levels of government as well. One concern is that local and regional media coverage has declined over the years, creating a greater disparity between the scrutiny given to state versus federal politics—which may explain why this career transition causes a significant decline in the values of affiliated companies.
The results “highlight the role of control as a very important check and balance mechanism,” says Nguyen.
