Finance: Research, Policy and Anecdotes

Last week saw the second edition of the London Political Finance Workshop, as last year on-line.  There were eight outstanding papers; as I won’t be able to do justice to all of them, a quick overview of some of them.

In Power, Scrutiny, and Congressmen’s Favoritism for Friends’ Firms, Kieu-Trang Nguyen and co-authors question the standard wisdom that “power tends to corrupt and absolute power corrupts absolutely”. Rather, using a Regression Discontinuity Design of close Congress elections in the US, they find evidence a politician’s win reduces his or her former classmates’ firms stock value by 2.8%. This adverse effect is most prominent among younger candidates, when career concerns are arguably the strongest. They explain this result with politicians reducing quid-pro-quo favours towards connected firms to preserve their career prospects when attaining higher-powered positions. Certainly a surprising result, but it clearly underlines the importance of scrutiny in restraining favouritism in politics.

In Does Political Partisanship Cross Borders? Evidence from International Capital Flows, Larissa Schäfer and co-authors gauge whether partisan perception shape the flow of international capital. Using data on syndicated loans and equity market funds, they  show that the ideological alignment or distance of individual investors/lenders in the US (based on political contributions by banks and voter registration for fund managers) with foreign governments affects the international capital allocation by large institutional investors. Specifically, considering investment in the  same country around the same foreign elections, the authors show that US banks reduce lending after an increase in the ideological gap after the election between their own (Republican or Democratic) political stance and the political stance of the foreign government and charge higher interests (while they do not face higher default); similarly, US mutual funds decrease portfolio allocation, again with no difference in performance. The authors also confirm the results for non-US investors (Canada and UK), even though with less granular data. Quite striking results, as partisan politics used to stop at the water’s edge; but it seems no longer so.

In Political Polarization in Financial News, Ryan Israelsen and co-authors find strong evidence of political polarization in corporate financial news.  Comparing coverage in the Wall Street Journal and the New York Times over 30 years on the largest 100 companies, they document that newspapers are more likely to cover and write positively about politically aligned firms (as measured by campaign contributions by employees and corporate political action committees to Democratic and Republican Party candidates). For example, an article in the WSJ about a firm that donated only to Republican Party candidates in the previous election cycle uses 20% more positive words than an article in the NYT, while an article in the WSJ about a firm that donated only to Democratic Party candidates uses 10% fewer positive words compared to the NYT.  And this different reporting also has implications for investment and trading. Specifically, there is more trading on days where there is more politics-induced disagreement in the reporting on a specific firm.  Finally,  matching data on individual investor trades from a retail brokerage data set to newspaper circulation data based on the zip code location of the investors, the authors find that when news about a stock appears in the newspaper an individual investor is more likely to read, the investor trades more and in the same direction as other investors who read the same paper.

In The Political Polarization of U.S. Firms, Elisabeth Kempf and co-authors show that executive teams in U.S. firms are becoming increasingly politically homogenous, based on voter registration records for top executives of S&P 1500 firms between 2008 and 2018.  This seems to be driven by politically misaligned executives more likely to leave, especially between 2015 and 17 and the effect is stronger in states where there is no legal prohibition of political discrimination, in firms with lower institutional ownership and for firms with CEOs with longer tenure.  The authors also show that differences in executives' political views manifest in differences in beliefs about the company's future stock price performance after political events, such as the surprise win by Donald Trump in 2016, with Democratic executives having a significantly higher likelihood of selling the firm’s share than Republican executives of the same firm after this specific event.

One of the highlights of the workshop was a keynote lecture by Renee Adams – to describe it as provocative would be an understatement.  Rather than presenting a paper, Renee decided to discuss her experience with the politics of finance academia – in her specific case, how a paper on the governance structure of Federal Reserve Banks ran into push-back (and rejection recommendations) by referees from the Federal Reserve system (who outed themselves as such). There is certainly a bias in our academic community to ‘not rock the boat’ and a risk of getting too close to authorities such as central banks that provide us with data and consultancies. The good news is that unlike ten years ago, this is now being openly discussed; the bad news is that we have only taken the first (baby) step in addressing this problem.

Overview