In an era of heightened political uncertainty – from gridlock in Washington to changes within the European Union – political risk has become a top concern for many boards of directors. Firms often cultivate political connections to mitigate these risks though  contributions, lobbying, and executives’ personal relationships.  In a recent study, we explore an additional approach: adding politically connected individuals to corporate boards.

Using a novel, firm-specific measure of political and non-political risk based on earnings call transcripts (Hassan et al., 2019), we show that firms facing increased political risk are significantly more likely to appoint politically connected individuals to their boards. We find that these appointments help firms mitigate the adverse effects of political uncertainty on investment decisions, but also inflict a cost on firms in the form of reduced board monitoring.

Political Risk and Politically Connected Director Appointments

Our findings show that appointments of politically connected directors are positively associated with the firm’s political risk but are not related to non-political risk. These appointments change the board’s overall structure. A one standard-deviation increase in firm-specific political risk increases the likelihood of appointing a politically connected director by 7.7 percent and raises the overall proportion of such directors by 7.4 percent. The results suggest that a board adapts to a shifting political landscape: When non-political risk increases, the fraction of politically connected board members declines.

Our results also reveal that not all political experience is valued equally. Directors who have served in the  executive or legislative branch of the federal government are more likely than those with state or local experience to be appointed by firms facing political uncertainty. However, we also find that former state politicians are appointed by firms headquartered in swing states when political risk is high. This aligns with literature suggesting that swing-state politicians often hold disproportionate sway in federal policymaking due to their bargaining power.

Politically Connected Directors Mitigate Political Risk—But at a Cost

We next test whether appointment of politically connected directors actually help firms navigate political risk. We examine the impact of these appointments on capital investment and employment. Consistent with prior studies, we show that political risk reduces both. However, when a firm appoints a politically connected director, these adverse effects are significantly mitigated. These results suggest that such directors enhance the board’s advisory function – perhaps by reducing informational asymmetries or facilitating access to policymaking.

But our findings also suggest a trade-off. The board holds both advisory and monitoring roles. When a firm appoints a politically connected director, the change in the board’s composition may be detrimental to its monitoring function. We find that politically connected appointments are associated with greater variation in discretionary accruals and revenues, indicators of reduced monitoring. This substitution effect is notable: While firms may gain from better political navigation, they may simultaneously lose some degree of financial oversight.

Governance Implications: Boards Are Not Static

Our findings contribute to a growing body of literature on the adaptive nature of corporate boards. We demonstrate that board structure is neither predetermined nor externally imposed, as prior research has often assumed, nor is it static; Instead, our results show that the board structure is shaped by internal dynamics, evolving in response to firm-specific risks and organizational needs.

A politically connected board may represent an underexamined source of influence that operates outside the traditional realms of campaign contributions or lobbying. A board’s political connections may be a longer-term alternative to conventional methods of navigating a fluctuating political landscape. For corporate leaders, our results underscore the importance of weighing the advising–monitoring trade-off when constructing the board.

Conclusion

As political risk continues to shape the corporate environment, firms are increasingly relying on their boards to help navigate uncertainty. Our research suggests that appointing politically connected directors can serve as a useful, if double-edged, tool in this effort. While such appointments may enhance firms’ ability to interpret and respond to policy shifts, they also raise questions about internal oversight and governance balance.

This post comes to us from Hagit Levy at City University of New York Baruch College’s Stan Ross Department of Accountancy, Emanuel Zur at the University of Maryland’s Robert H. Smith School of Business, and Sae Young Yoon at Framingham State University. It is based on their recent paper, “Countering Political Risk with Board Appointments,” available here.