The potential for corporate campaign contributions to skew government policy has attracted considerable attention. Empirical studies generally support the notion that firms gain regulatory advantages through their involvement in the political process (e.g., Correia, 2014; Naughton, Rogo and Zheng, 2021). The notion that corporations also benefit financially from political influence has led to demands for making their lobbying more transparent (e.g., Bebchuk, Jackson, Nelson, and Tallarita, 2020), both to protect shareholders and to uphold the integrity of the U.S. political system. In contrast, individual donations by executives are believed to be relatively benign, seen generally as motivated by ideology rather than private gain (e.g., Cohen, Hazan, Tallarita, and Weiss, 2019; Babenko, Fedaseyeu, and Zhang, 2020).
In a recent paper, we take a different view and suggest that CEOs also make political contributions to obtain direct private benefits. This view offers new insights into corporate political engagement and the potential for self-interested contributions to damage the U.S. political system. Our focus on private benefits distinguishes our approach from studies that treat executive political contributions as an extension of a firm’s political activities (i.e., the CEO contributes to the same individuals or entities as the firm, and both types of contributions are intended to advance the interests of the firm). Because we are focused on private benefits for the CEO, we do not examine executive compensation, because it is often closely tied to firm performance through, for example, stock-based compensation. Rather, we focus our empirical analyses on the Securities and Exchange Commission’s enforcement of accounting fraud, because releases announcing enforcement actions against a firm can specifically name executives, imposing substantial costs on those executives (e.g., Davidson 2021; Karpoff, Lee, and Martin, 2008). In broad terms, our analyses investigate whether CEOs engage in the political process to ensure that they are not named in SEC enforcement actions.
We first identify whether CEOs increase their political contributions when they are likely to be subject to an SEC enforcement action. Intuitively, CEOs are more likely to be concerned about SEC enforcement when the firm is being aggressive with its financial reporting. Empirically, we examine whether CEOs increase their political contributions during years that were subsequently identified by the SEC as when financial reporting misconduct occurred. Our baseline model shows that CEOs’ personal contributions almost double in amount (88.9 percent) during misconduct years. The magnitude of the effect remains striking even after controlling for firm characteristics and the addition of a variety of fixed effects, including that particular industry, firm, and CEO.
The timing of events is particularly revealing. We identify two-year periods before and after the misconduct, and show, using a dynamic difference-in-differences specification, that the pattern of contributions spikes during the first year of the misconduct period. It is not the case that the contributions are simply increasing over time. This aspect of our results indicates that the changes in CEO contributions we identify are not driven by a constant desire to create political connections, as is assumed in much of the literature that examines political connections. Rather, our data reflect that CEOs try to buy influence when they need it most, consistent with a transactional rather than a relational view of political contributions.
The nature of the contributions is also very revealing. CEOs may make contributions to specific house or senate candidates, a presidential candidate, or a political action committee (“PAC”). Prior studies have noted that the type of contribution varies based on the goal of the donor. For example, CEOs may make additional contributions to parties because they want to secure high-profile political jobs (e.g., an ambassadorship). Influence acquisition is most evident in contributions to specific house candidates, followed to a lesser extent by senate candidates, due to the fact that the former face a two-year election cycle and the latter a six-year election cycle (e.g., Gordon, Hafer, and Landa, 2007). This outcome is precisely what we find in our data. The increased contributions during the misconduct period are directed primarily to house candidates and secondarily to senate candidates, and there is no detectable increase in contributions to presidential candidates or PACs. Collectively, these results are consistent with our suggestion that the increased contributions during periods of misreporting are intended to acquire political influence.
The documented time-series pattern in the specific type of political contribution is difficult to reconcile with alternative explanations. We find that CEOs increase their political contributions to candidates who can provide influence specifically during misconduct periods, where the likelihood of SEC enforcement increases. We provide further support for our interpretation through an empirical specification that exploits the effect of Section 906 of the Sarbanes-Oxley Act of 2002 (“SOX”), which requires CEOs and CFOs to certify financial information and periodic reports filed with the SEC. This provision dramatically increased the likelihood that a CEO would be targeted personally by the SEC. We find that CEOs almost doubled their contributions during misconduct periods after SOX. This finding is consistent with the notion that a greater risk of being targeted personally by the SEC leads to increased personal contributions.
Lastly, we consider whether personal investment in political capital pays off. We find that, where firms are targeted by the SEC, CEOs who make higher personal contributions face a lower likelihood of being sued. We find an even lower likelihood of being sued for CEOs who increase their contributions the most during misconduct periods. These findings suggest that CEOs make personal political expenditures to gain the private benefit ofmitigating the risk of facing a costly enforcement action.
Our evidence indicates that CEOs make personal political contributions when they face an increased risk of an SEC enforcement action. From a practical standpoint, our findings provide useful insights into the debate about limiting corporate participation in electoral politics (e.g., the Ban Corporate PACs Act), a central focus of campaign finance reform (Richter and Werner, 2017). Our paper challenges the idea that banning (or voluntarily rejecting) corporate PACs would end the dominance of corporate special interests in Congress.
Babenko, I., Fedaseyeu, V., & Zhang, S. (2020). Do CEOs Affect Employees’ Political Choices? The Review of Financial Studies, 33(4), 1781–1817.
Bebchuk, L. A., Jackson, R. J., Nelson, J. D., Tallarita, R. (2020) The Untenable Case for Keeping Investors in the Dark,” Harv. Bus. L. Rev., 10, 1
Cohen, A., Hazan, M., Tallarita, R., & Weiss, D. (2019). The Politics of CEOs. Journal of Legal Analysis, 11, 1–45.
Correia, M. M. (2014). Political connections and SEC enforcement. Journal of Accounting and Economics, 57(2), 241–262.
Davidson, R. H. (2021). Who did it Matters: Executive Equity Compensation and Financial Reporting Fraud. Journal of Accounting and Economics, forthcoming.
Gordon, S. C., Hafer, C., & Landa, D. (2007). Consumption or Investment? On Motivations for Political Giving. Journal of Politics, 69(4), 1057–1072.
Karpoff, J. M., Scott Lee, D., & Martin, G. S. (2008). The consequences to managers for financial misrepresentation. Journal of Financial Economics, 88(2), 193–215.
Naughton, J. P., Rogo, R., & Zheng, X. (2021). Why do Companies meet with the SEC Chair? University of Virgina, unpublished working paper.
Richter, B. K., & Werner, T. (2017). Campaign Contributions from Corporate Executives in Lieu of Political Action Committees. The Journal of Law, Economics, and Organization, 33(3), 443–474.
This piece comes to us from Wenjiao Cao at Erasmus University Rotterdam, James P. Naughton at the University of Virginia’s Darden School of Business, Rafael Rogo at the University of Cambridge’s Judge Business School, and Ray Zhang at Simon Fraser University’s Beedie School of Business. It is based on their recent paper, “CEO Political Engagement and Personal SEC Prosecution,” available here.