Monday, March 10, 2008

Democracy: Buy the stocks that buy the US politicians

Monday, 10 March 2008

The Guardian

It really is as simple as that, as Proinsias O'Mahony reports. In fact, it's a 'no brainer' with a possible 654,836% returnProinsias O'MahonyHow do you pick a top-performing share? Investors looking to beat the market needn't numb their minds with heart-breakingly tedious fundamental research. No, the secret to market-beating returns is a simple and, now that the US presidential election is getting into full swing, a timely one - buy the stocks that buy the politicians.
That's the conclusion reached by the authors of Corporate Political Contributions and Stock Returns, a US study that found that the companies that have generously contributed to party coffers have beaten the market by 2.5% a year over the past 25 years.Looking at more than 800,000 contributions from almost 2,000 companies, the authors conclude that "evidence of political contribution return effects is quite startling", with the average firm increasing its shareholder wealth by more than $150m per year.Interestingly, firms are better off showering modest amounts of money on as many candidates as possible, rather than spending big bucks on a handful of politicians. Why? "Much like a venture capital portfolio of many start-ups, a few of the supported candidates will 'pay off big' and result in increases in firm shareholder wealth," the study says, with "an increase in annual returns of approximately 6% a year" accruing to firms that contribute to the most candidates. The saying that diversification is the only free lunch in finance never seemed more appropriate. For most firms, the costs involved in getting politicians on their side are minor. A limit of $10,000 per candidate in each election is enforced, but the authors note that smaller contributions are just as likely to result in share price gains. As a result, investing in politicians is a no-brainer, with "the annual return-on-investment from a portfolio weighted by the total-number-of-supported-candidates to be an absurdly high 654,836%".One could argue that market perception of political favours might be enough to cause share price appreciation. The fact that the contributing companies also experienced greater future profitability suggests that political favours were real rather than perceived, however. Further evidence lies in the fact that the "contribution effect" is greatest for companies that give to the most powerful politicos (for example, congressional committee heads), to home-state candidates and to congressional, rather than senate, contenders (budget and tax laws originate in Congress). Potential benefits include "favourable tax treatment ... the awarding of government contracts, the imposing of tariffs or other penalties on competitors, and implementing favourable regulatory requirements".Once a politician has served his or her purpose, the relationship alters. "Firms decrease their contributions to politicians who are expected to soon retire or change their affiliation from the committee that has jurisdiction over the firm's operations, to the committee with no such jurisdictions".While this would suggest that politicians are selling themselves short, the study suggests "there may be other substantial hidden costs, above and beyond hard-money contributions". A possible translation of the above might be that gift vouchers, free flights and free accommodation in swanky hotels might be on offer.It's hard to imagine that happening in the UK, of course. Few British quoted companies donate money directly to political parties any longer, although individual directors may do so. The 2000 Political Parties, Elections and Referendums Act required shareholders to approve donations from listed companies, since when corporate donations have shrivelled. More common is the corporate sponsoring of political events . Would-be investors in US stocks should concentrate on the many generous companies in the defence, tobacco, automobiles and oil sectors, while avoiding forays into real estate and precious metals - they're a stingier bunch. Finally, while Republican candidates receive more corporate money, companies that fund Democrats enjoy the best returns.A murky road, from Hitler to JFKA long and murky relationship exists between politicians and their financial benefactors."From Indonesia and Malaysia to Italy, politically connected firms are more valuable than their less fortunate competitors," say the authors of a paper, Betting on Hitler - The Value of Political Connection in Nazi Germany. They found that "helping to undermine democracy at important junctures produced high returns" and companies with board members "known to favour the party (or backing it financially) outperformed the market by 6% to 9%" immediately after Hitler's accession to power. A 2006 research paper, looking at 157 announcements across 35 countries, found the market capitalisation of a firm increases by an average 2% when a large shareholder enters politics.A separate study found firms decline in value by 2% when a legislator "connected" to a firm dies ("connected" is defined as living in, or born in, the same city in which a firm operates). Another paper analysed government bail-outs of financially distressed companies from 35 countries between 1997-2002 and found "politically connected firms are significantly more likely to be bailed out than similar non-connected firms". Most studies found that such market anomalies are even more noticeable in countries rife with corruption. Brazil lived up to its reputation when Dutch scholars found that firms contributing the most money to federal deputies contesting the 1998 election experienced the highest stock returns after the election. A 2001 study of Indonesian firms connected to the then ruling Suharto family found that announcements of the president's declining health caused decreases in the firm's market value.While US corruption may not be as obvious as that seen in Suharto's Indonesia or Hitler's Germany, a paper entitled Friends in High Places: The Wealth Effects of JFK's Assassination on the Assets of LBJ's Supporters" indicates that political favouritism is not a new phenomenon. Market reaction to the president's death indicated that it expected "significant benefits to accrue" to firms connected to vice president Lyndon Johnson. The authors go on to relate a joke that did the rounds during the duo's 1960 campaign. Kennedy, a Catholic, tells Johnson that "when we get elected I'm going to dig a tunnel to the Vatican". LBJ's reply? "That's OK with me as long as Brown & Root gets the contract."

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