Capital Markets

Political Payouts: an Offer You Can’t Refuse?

While board members feel that nothing good can come of political contributions, they fear their companies need to make them—or else.
David KatzMarch 3, 2008

Board members feel that corporate political contributions are “like protection money” and must be paid merely to avoid dire consequences, a political pollster says, extrapolating on a new study that finds that most directors think political payouts don’t do corporations any good.

Indeed, 66 percent of the 255 directors polled for the study—57 percent of them company managers and 43 percent outside directors—say that political advocacy and spending did not result in “instances of favorable legislative, regulatory, or tax treatment” of their companies and/or industries.

At the same time, 63 percent of the board members agreed with the statement that “[e]ffective and active political advocacy by our industry, including fundraising and spending, is essential to our industry’s competitiveness and bottom line,” according to the study, which is based on interviews with directors of Russell 2000 companies performed by Mason-Dixon Polling & Research in February.

In other words, most of directors feel that nothing good will come of their companies’ political contributions. “But something bad will happen if they don’t play the game,” Larry Harris, a principal of Mason-Dixon, said at a conference on “Money, Politics, and Corporate Risk” at Baruch College in New York last Thursday, in characterizing their views. “They’re going to get their legs broken.”

Yet there are other indications that corporate political contributions may be ill spent. The probability of getting sued for corporate fraud is higher among companies that make political contributions, according to Tracy Yue Wang, an assistant professor of finance at the University of Minnesota’s Carlson School of Management.

In calculations done for CFO.com, Wang found that among all publicly held corporations (11,825), only 8.4 percent were sued by the Securities and Exchange Commission for alleged accounting and auditing violations and in class-action litigation between 1996 and 2005. In contrast, 13.4 percent (222) of companies dishing out political contributions (1657) during that period were sued.

Wang believes that that higher incidence of lawsuits against companies that contribute to political causes and politicians stems from a “poor corporate governance system,” that often includes overly large boards, top officers who combine the chief executive and chairman slots, and dispersed corporate ownership. Specifically, the increased suing of donators is generated by an “agency problem” at those companies—a situation in which the managers or decision makers of the company aren’t owners or at least own very few shares, she told CFO.com.

The executives at companies that indulge in political payouts may also be poorer financial managers. In a 2007 research paper cited at the Baruch meeting, Wang and her co-authors found “that firms that donate have operating characteristics consistent with the existence of a free cash flow problem.” Although such companies have loads of free cash flow, they tend to be overleveraged, invest relatively little in research and development, and squander big bucks in mergers and acquisitions. Companies “with excess free cash flow may be willing to engage in both wasteful political donations and acquisitions,” according to the authors.

Such companies might also be led by directors who are ignorant of corporate campaign-finance laws, the Mason-Dixon research suggests. For example, 73 percent of the directors responding to the study, which was sponsored by the Center for Political Accountability, incorrectly think that under current law, corporations are required to “publicly disclose all of their campaign spending.” Companies, however, are not required to disclose their political spending.

Not surprisingly—since most of them think their corporations are already required to do so—88 percent of the directors support a requirement that corporations “publicly disclose all corporate funds used for political spending,” Harris pointed out.