Governance | Securities Regulation

How a CEO's campaign contributions can affect regulatory outcomes

The idea that corporate campaign contributions skew political and regulatory outcomes in favour of special interests has attracted a lot of policy interest. The existing body of research examining corporate political connections generally supports the idea that firms gain regulatory advantages through their involvement in the political process (i.e. political donations).

The mere idea that corporations benefit financially through political influence has led to calls for increased transparency or the outright banning of corporate lobbying activities to uphold the integrity of the U.S. political system. In contrast, individual donations by executives continually slip under the radar and are often viewed as benign and ideologically motivated rather than an attempt to gain personal benefits.

In our paper CEO Political Engagement and Personal SEC Prosecution, we take a different view and suggest that CEOs may make political contributions to obtain direct private benefits. This new perspective could shed light on important issues of corporate political engagement and how self-interested contributions can negatively affect the U.S. political system.

Our focus on personal benefits distinguishes our approach from studies that treat executive political contributions as an extension of the firm’s political activities (i.e. the CEO and firm contribute to the same individuals or entities to advance the firm’s interests). As a result, we focus our empirical analyses on the Securities and Exchange Commission (SEC) enforcement of accounting fraud. We focus on these because enforcement proceedings can name specific executives, often resulting in substantial costs to those individuals. Our analyses investigate whether CEOs engage in the political process to benefit from not being personally named in SEC enforcement actions.

The first step is to identify whether CEOs increase their political contributions when they are more likely to be subject to SEC enforcement. We find that CEOs are more likely to be concerned about SEC enforcement when their firm is aggressive with its financial reporting. We then empirically examine whether CEOs increase their political contributions during the years identified by the SEC as years where misconduct occurred. Our model shows that CEOs’ contributions nearly double (88.9%) during these years. The magnitude of the effect is striking even after controlling for firm characteristics and the addition of a variety of fixed effects, including industry, firm and CEO fixed effects.

The timing of events is particularly revealing. We have identified two-year periods before and after the misconduct period and show, using a dynamic difference-in-differences specification, that the pattern of contributions spikes specifically during the first year of the misconduct period. It is not the case that the contributions are simply increasing over time.

These results indicate that the changes in CEO contributions we identified were not driven by an ongoing desire for political connections, as is assumed in much of the literature that examines political connections. Instead, our data reflect a transactional rather than relational view of political contributions, where CEOs make significant contributions because their need for influence is high.

The nature of the contributions is also very revealing. CEOs may contribute to specific house or senate candidates, presidential candidates, political parties, or a political action committee (PAC). Prior studies have noted that the type of contribution varies based on the donor’s goal. Donors looking to acquire influence are best served by donations to specific house candidates and, to a lesser extent, senate candidates. This is because the former faces a two-year election cycle while the latter has a six-year election cycle.

This outcome is precisely what we find in our data. Our data show that increased contributions during the misconduct period are primarily directed to house candidates, secondarily to senate candidates, with no detectable increase in contributions to presidential candidates or PACs. These results are consistent with our suggestion that the increased contributions during periods of misconduct are intended to acquire political influence.

The mechanisms of influence that members of Congress and senators have over institutions like the SEC are relatively straightforward. The three major mechanisms of influence are budget setting, the threat of personnel turnover, and congressional oversight. Also, SEC commissioners could benefit from their political alignment with elected politicians. For example, the SEC is more likely to be granted budget increases if the organization acts in alignment with the will of elected officials.

The documented pattern in the specific type of political contribution is difficult to reconcile with alternative explanations. We find that CEOs increase their political contributions to the types of candidates that 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 personally prosecuted by the SEC. We find that CEOs increased their contributions almost twice as much during misconduct periods after SOX. This finding is consistent with increased personal enforcement costs leading to increased personal contributions.

Lastly, we consider whether personal investment in political capital pays off. We find that in cases where firms are prosecuted by the SEC, CEOs who make higher personal contributions face a lower likelihood of personal prosecution. We see an even greater reduction in the likelihood of personal prosecution for those CEOs that increase their contributions the most during misconduct periods. These findings suggest that CEOs use personal political expenditures to gain private benefits by reducing their personal risk of regulatory enforcement costs.

Overall, our evidence indicates that CEOs engage in the political system through personal contributions when they face an increased risk of SEC enforcement. From a practical standpoint, our findings provide valuable insights into the debate about limiting corporate participation in electoral politics, a central focus of campaign finance reform. Our paper challenges the idea that banning (or voluntarily rejecting) corporate PACs would end the dominance of corporate special interests in Congres.

Ray Zhang is an assistant professor at the Beedie School of Business at Simon Fraser University. His research areas include securities regulation & enforcement, bank loan contracting and auditing.

A similar story was recently published on the Columbia Law School’s Blue Sky Blog on Corporations and the Capital Markets.