Friends in Low Places: The Impact of Political Scandals on Connected Firms’ Stock Prices
Having “friends in high places” can bring many benefits. But what happens if these “friends” are involved in shady business dealings, use taxpayer funds to finance lavish offices or vacations, are subject to sexual harassment lawsuits, or express homophobic or xenophobic views?
We use the exogenous nature of political scandals to test whether political connections in the form of campaign contributions expose firms to reputational risk. We hand-collect a sample of 218 scandals of members of the U.S. Congress that occurred between 2000 and 2019 and estimate the abnormal returns around the day a scandal first appeared in the news. We find that connected firms and to a lesser extent other politically active firms experience value losses around corruption scandals involving firms or lobbyists. These losses increase in managers’ propensity to engage in unethical behavior. Moreover, we find that shareholders of connected firms are more likely to submit proposals on the disclosure of political contributions following such corruption scandals, and that connected firms reduce political spending. Overall, our results suggest that losses around scandals are mainly driven by reputation spillover and investors updating their beliefs about the risks of political contributions.
A summary of the paper can also be found at The FinReg Blog.
Co-Author(s): Jacco Wielhouwer