A Comprehensive Analysis of the Externalities of Corporate Political Connections: Evidence from Close Elections

Firms often seek political connections which affect corporate business and valuation. The literature on political connections in corporate business and finance has offered various channels in which politically connected firms benefit from political connections. For example, these firms can gain more government contracts, easier access to financing, and increased sales; some are more likely to be bailed out in distress and less disciplined. But the overall benefit of corporate political connections is not apparent if one looks beyond the directly-connected firms. Political connections can be private goods exclusive to the connected firms but hurt other firms. But they can also serve as common or public goods benefiting all firms in the same industry.This project will investigate and evaluate the spillover effect of political connections among business peers. If a firm’s valuation gets impaired by the political connections of its business peers or rivals, public concerns about the political connection’s overall benefits are warranted. If the spillover effect is positive instead, the general view on political connections may become more lenient.This research plans to examine how political connections spill over to other firms if business peers who make political contributions subsequently have their supported politicians winning in close elections in the U.S. The close elections have election outcomes within a 5% margin of winning votes. Previous research found that close elections have a sufficient random component of political connections to provide quasirandomized experiments for testing the effect of political connections.We will conduct an event study to estimate and evaluate the valuation effect on a firm when its business peers unexpectedly gain political connections from close elections. We will examine the spillover effect’s conditions that underlie and facilitate the externalities, such as in regulated and homogenous industries as well as in high economic policy uncertain periods. Political connections involve political power and influence in legislation. Once passed, congressional bills related to industry-specific government regulation and policy potentially affect directly-political-connected firms and other firms in the same industry. We will test whether regulatory changes through bill passing are an explicit political-influence channel for facilitating positive or negative externalities.The analysis of spillover effects of political influence will fill the void in the literature on corporate political power. The project’s results can also guide the Hong Kong government in promoting economies across China’s Greater Bay Area, where subtle political interactions in cross-border businesses are bound to affect local corporate valuation and decisions.