Corporate Political Contributions: Investment or Agency?

Abstract

We examine corporate contributions to political candidates for federal offices in the United States from 1991 to 2004. We find that firms that donate have operating characteristics consistent with the existence of a free cash flow problem. Further, donations are negatively correlated with future excess returns. An increase in donations of $10,000 is associated with a reduction in annual excess returns of 9.6 basis points. We find that worse corporate governance is associated with larger donations. However, even after controlling for corporate governance, we find that donations are associated with worse excess returns. Firms that make donations engage in more acquisitions and donating firms acquisitions have significantly lower cumulative abnormal announcement returns than firms that do not make donations. When we try to isolate instances in which donations may lead to better returns, we find only limited support for the hypothesis that political donations represent an investment in political capital. Taken together, our results suggest that political donations are more symptomatic of agency problems within the firm.