Study: Big Corporate Donors Are Bad Investments

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How about this for a new investing strategy: Avoid the stock of companies that make big political contributions. The more they give, it seems, the worse their share prices perform. That’s the conclusion of a new study, which found that for every $10,000 in direct political donations a company makes, its share price underperforms by 0.074% annually. While this may seem small, it works out to an average “cost” to shareholders of $1.33 million in market value a year for every 10 grand donated. “We find virtually no support for the hypothesis that donations represent an investment in political capital,” write the study’s authors.Published in the April issue of Business and Politics, the study examined corporate political donations from from 1991 to 2004, focusing on “the four main types” of political giving: political action committee (PAC) donations, donations by individuals affiliated with a company, soft money donations and donations to 527 Committees. Interestingly, only 11.27% of all publicly traded U.S. companies donated directly from company funds during the sample period—a total of  1,381 firms. That’s a good thing, too, at least as far as investors are concerned. According to the researchers (Felix Meschke at Kansas, and the U of M’s Rajesh Aggarwal  and Tracy Yue Wang), a higher rate of political donation is associated with generally “worse corporate governance” in the classic definition of the term. In other words, companies that throw a lot of money at politics are more likely to have giant boards, CEOs who double as chairman, below-average institutional ownership and above-average CEO pay. No wonder these outfits’ share prices underperform!

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Of course, there’s a chicken-or-egg question here: Do poor managers resort to donations as a way to overcome their faults? Or are smart managers in difficult situations forced to try everything, including attempts at political influence, to overcome their challenges? There’s no easy answer, and the researchers’ other insights offer differing perspectives. On the one hand, approximately 42% of all corporate political donations are made by companies operating in five industries: financial trading, telecommunication, utilities, banking and transportation. So it’s tempting to speculate that corporate attempts at political manipulation, whatever one thinks of their moral legitimacy, are to be expected from firms so affected by government regulation. (The largest single donor in their sample was Altria, parent company of Philip Morris.) It would be dumb, and arguably irresponsible, for C-suite types to pass up the chance to influence the people who regulate them (to the extent the law allows).

On the other hand, the researchers also found that firms with high donation rates have more free cash flow than their peers but lower rates of R&D spending. That is, many of the biggest corporate political givers have lots of excess cash that they’re not investing in the future. This hardly seems smart, especially when you consider where some of that money ends up: acquisitions. Turns out, big corporate givers are also big corporate buyers, engaging in more acquisitions than non-donating firms. And, after controlling for other factors, these acquisitions have “significantly lower cumulative abnormal announcement returns” those of non-donating firms. Translation: Big givers equal below-average investors.

Which is what you might be if you invest in companies that throw lots of money at their problems in lieu of actually solving them.

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