How 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 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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