Political Connections Boost Stock Price, Study Finds
Does a firm profit from the political appointment of one of its members? Yes. Does a firm profit from hiring a former political appointee? Yes.
While in the same genus as lobbying, the so-called “revolving door” is a different species altogether (which happened to spin wildly today, with the revelation that former Congressman Steve Buyer, an Indiana Republican who once fought tobacco regulation by comparing cigarettes to lettuce, has signed on as a paid consultant and lobbyist for RJ Reynolds).
As described by the Center for Responsive Politics:
The authors of the study, Swiss economists Simon Luechinger and Christoph Moser looked at defense contractors and Department of Defense appointees over six presidential administrations, from Bush Sr. to Obama, and asked: “Do firms profit from the political appointment of one of its members? Do firms profit from hiring a former political appointee?”
Although the influence powerhouses that line Washington's K Street are just a few miles from the US Capitol building, the most direct path between the two doesn't necessarily involve public transportation. Instead, it's through a door -- a revolving door that shuffles former federal employees into jobs as lobbyists, consultants and strategists just as the door pulls former hired guns into government careers. While officials in the executive branch, Congress and senior congressional staffers spin in and out of the private and public sectors, so too does privilege, power, access and, of course, money.
Indeed, they do:
“But,” Luechinger and Moser write, “the revolving door works in both ways. For corporate appointments (“ex post”), the announcement results in average positive abnormal returns of 0.79% and 1.05% for one- and two-day event windows, although these results are statistically less strong. We find that stock market reactions tend to be higher for nominations to the board of directors and for corporate appointments of former political appointees of a Democratic president. The baseline results are robust to the exclusion of extreme abnormal returns, scaling of abnormal returns and the adjustment of returns by industry returns.”
For political appointments (“ex ante”), we find positive average abnormal returns of 0.82% and 0.84% for the one- and two-day event windows, respectively. Abnormal returns are larger for (former) board members, top pay-grades in the Department of Defense, appointees nominated by a Democratic administration (for the one day window) and for those events, where the announcement was at least partly unanticipated.
To recap: Leave a company for a government post, the company’s stock goes up. Leave a government post for a company, the company’s stock goes up.
Could It Really Be as Brazen as It Seems?
“[It] is hard to think of other reasons for higher expected returns than conflicts of interest,” Luechinger and Moser write. “In the best case, conflicts of interest distort procurement contract award competitions, because some firms have informational advantages. In the worst case, decisions are tilted towards specific firms and against the interest of taxpayers and the armed forces.” As for the other side of the equation, Luechinger and Moser explain, in no uncertain terms, that investors “expect firms to profit from their political connections to appointees.” (In the defense sector alone, it is difficult to identify a major company without former military officials on the board of directors, from Lockheed Martin (NYSE:LMT) to Raytheon (NYSE:RTN) to Northrop Grumman (NYSE:NOC). Honeywell (NYSE:HON) is a notable exception, with no retired generals -- though having former US Senator Judd Gregg around the boardroom certainly can’t hurt.
Luechinger and Moser continue:
Reaction to the study has been pointed.
Political appointees have both opportunities and motives to act in favor of their former employers. Preferential treatments can come in different disguises: Directly in procurement, regulation and oversight, and supervision of mergers and acquisitions; indirectly in strategic planning and preferential access to decision makers and information. At the same time, political appointees also have incentives for preferential treatment towards their former employers either because they expect to rejoin the companies or because they want to return favors. Similarly, former political appointees bring valuable connections and information about processes, upcoming decisions and competitors to firms hiring them upon leaving government service.
Bart Naylor, financial policy analyst at non-profit watchdog group Public Citizen, tells me that, “At the very least, the study underscores the problem that the revolving door translates into potential misallocation of taxpayer dollars. Stock investor wisdom may not be perfect, but counts more than idle forecasts by those not risking their personal savings.”
“This study shows that investors bet real money that the revolving door raises the chance a firm will win lucrative government contracts,” Naylor continues. “In other words, it’s a sad fact that political influence has become an axiom of sober investment calculation.”
The data fills in the rest of the admittedly bleak picture. Luechinger and Moser point to several examples:
Going in the other direction, Luechinger and Moser point to the fact that political appointees “may expect to return to the company or at least want to keep this option alive,” noting that roughly “28% of appointees move to the industry after leaving their current position at the Department of Defense,” highlighting former Defense Secretary William J. Perry’s re-joining of the board of directors at United Technologies (NYSE:UTX) after leaving the Pentagon.
When Gerald A. Cann, General Dynamics Corp.'s (NYSE:GD) former chief of undersea warfare, became Assistant Secretary of the Navy (Research, Development, and Acquisition), he had to select among three standoff anti-submarine weapons, one of which he developed at his former employer. “It is a little wrong to be involved with a weapon system [in industry] and then be put in charge of deciding [at the Department of Defense] what system will replace the one that’s performing the mission now,” said Sen. Al Gore.
When James G. Roche, a former Northrop Grumman Corp. executive, served as Secretary of the Air Force, he was the source selection authority in the F-35 competition and his former employer a main partner of one of the bidders. This team ultimately won and was expected “[…] to dominate warplane construction worldwide for the first half of this century.”
Direct preferential treatment is also possible in case of regulation and oversight and supervision of mergers and acquisitions. As Assistant Secretary of the Air Force (Installations and Environment) Terry A. Yonkers was in charge of drafting environmental regulations of the Air Force, affecting his former employer Arcadis NV. John M. Deutch, Under Secretary of Defense (Acquisition, Technology, and Logistics), followed an initiative of Martin Marietta’s head and approved a new rule allowing the Department of Defense to partly cover merger costs. Later, as Deputy Secretary of Defense, he gave the nod to the merger between Lockheed Corp. and Martin Marietta Corp.. This merger eventually cost the Department of Defense more than USD 1 billion. Did we mention that he was formerly a member of the advisory board of Martin Marietta Corp.?
While the authors do mention William Lynn, a Pentagon official under Clinton who left to join Raytheon only to return as President Obama’s nominee for Secretary of Defense, Craig Holman, Public Citizen’s government affairs lobbyist -- and perhaps the nation's foremost expert regarding the revolving door -- says it is not representative of the administration’s practices overall.
“Lynn was Obama’s only mistake on the revolving door,” Holman tells me. “Lynn was appointed because the Clintonites running Obama’s transition team neither cared nor understood Obama’s executive order on the reverse revolving door. After that appointment, which Obama tried minimizing by issuing a waiver for Lynn the next day after I was screaming bloody heck, Obama clarified to the transition team his policy against the revolving door. It didn't happen again. The one thing I want to see in the study is whether, as I strongly suspect, there was a precipitous decline in investment abuse under Obama compared to previous administrations.”
What to Do?
Duke University Law Professor Lawrence Baxter teaches regulation and its reform. He tells me he doesn’t “find anything surprising in this study, but it is good to see some scientific measurement developed to confirm the instinctive judgment that connections between industry and government, particularly at the highest levels, matter in a financial sense, even without any form of corruption.”
The problem, he says, “becomes what to do about it, which is particularly difficult when we need expertise in government.”
“I believe that the best way to handle the conflicts is mandatory full disclosure so that third parties, including the media, are aware of former, current and potential connections,” Baxter says. “I am constantly surprised at how difficult it is to secure such disclosure. (The SEC has done a better job than other agencies, as best I can tell.) I am not sure that barring contacts for a period of time really works because that defeats the more laudable purposes of the revolving door (insuring a flow of expertise, etc.).”
This flow of expertise is something Jamie Fly, a civilian Pentagon staffer during the Bush administration, and the current executive director of the Foreign Policy Initiative in Washington, DC, wants to keep open.
“A no-lobbyist policy may [be] a great campaign pledge, but in reality, there are a lot of very talented people in Washington who have done lobbying work, which shouldn’t preclude them from working for the government in the future,” Fly told me back in 2010.
This would appear to make sense on most levels. However, as with most scenarios in Washington, black-and-white gives way to an area quite gray.
"On the one hand, if you don’t have defense-industry experience, then you’re lacking critical insight," a defense analyst is quoted as saying in Luechinger and Moser's study. "On the other hand, if you do, it’s inevitable that in some way it’s going to impact on your judgment."
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