MSc Thesis, Business Administration: Strategy Final paper: 17 August 2017
Corporate Governance and the
CPA-CFP relationship
Robert Mourik, 11419040
Amsterdam Business School, University of Amsterdam, North-Holland, The Netherlands. Supervisor: Dr. P. Vishwanathan, University of Amsterdam
This study will investigate the corporate political activity (CPA) – corporate financial performance (CFP) relationship from a corporate governance perspective. As authors have indicated the role of agency problems with CPA, we investigate whether measures of good governance affect the amount of corporate political activity and if good governance moderate the CPA-CFP relationship. On top of that, we looked for indirect effects of Corporate Governance on Corporate financial performance through corporate political activity. We find that good governance reduces corporate political spending, and that there is a small positive relationship between corporate political activity and corporate financial performance. This indicates that CPA is agency driven, but not necessarily negative for the firm and its shareholders.
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Statement of originality
This document is written by student Robert Mourik, who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
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Table of contents:
Introduction Page 3
Theoretical background and hypotheses Page 6
Corporate Political Activity Page 6
CPA-CFP Page 7
Agency theory and Corporate Governance Page 9
Data & Methods Page 17
Independent variables Page 17
Dependent variables Page 18
Control variables Page 19
Analyses Page 19
Results Page 21
Discussion Page 33
Limitations Page 36
Future research Page 36
References Page 39
Appendix Page 47
A, Normality checks Page 47
B, Linearity checks Page 61
3 | P a g e Introduction
The relation between politics and business has been in the spotlights for quite some time now. Since the financial crisis of the late 2000’s and early 2010’s, mostly caused by banks, public institutions have been busy forming policies and regulations to control firms and their risk taking behavior1. Meanwhile, firms invest millions of dollars in politics; they hire lobbyists, open Washington DC offices and donate money through PAC’s and Super PAC’s to turn the ‘odds’ in their favor. These investments are also called corporate political activity, or CPA (Hillman et. al., 2004). A key assumption in most theoretical perspectives on CPA, is that firms engage in corporate political activity in order to obtain and/or maintain economic returns (North, 1990, Lux et. al., 2011), and most authors assumed CPA to be positively related to firm performance (Bonardi et. al., 2006, Hillman et. al., 1999). However, recent empirical research suggests that the aforementioned relation between corporate political activity and firm financial performance is not necessarily positive, and some authors even suggests it to be negative (Aggarwal, 2012, Hadani & Schuler, 2013). This study aims to contribute to the emerging body of research on the corporate political activity – firm financial performance relationship.
Specifically, this study draws attention to possible agency problems related to corporate political activity. Several scholars have indicated a possible asymmetry between firm and managerial interests concerning corporate political activity (Aggarwal, 2012, Sun et. al., 2012, Hadani & Schuler, 2013, Ozer & Alakent, 2013). When the interests of managers and owners diverge, there is potential for mischief (Dalton et. al., 1998). This results in the necessity of monitoring mechanisms, designed to protect the shareholders of the firm. This
1
BBC, ‘’Banking Reform, what has chagned since the crisis?’’, http://www.bbc.com/news/business-20811289, consulted at 01-05-2016
4 | P a g e study dives deeper into the role of corporate governance and the CPA-CFP relationship, as monitoring is one of the primary duties of the board of directors (Fama & Jensen, 1983, Jensen & Mecklink, 1976, Dalton et. al., 2007). Therefore, we will test how good governance affects corporate political activity and the corporate political activity-corporate financial performance relationship.
The first part of this study will contribute to the growing branch of research empirically investigating the effects of non-market strategies on organizational performance, making use of very recent data. This part of the study will also help managers to better assess the advantages and disadvantages of investing in corporate political activities.
The second part of this study investigates the relationship between measures of corporate governance and corporate political activity. This part of the study will contribute to the understanding of agency problems involved with corporate political activity, and how good corporate governance increases affects corporate political investments. This research contributes to theory by further assessment of the corporate governance and corporate political activity relationship.
This research further contributes to theory by assessing the moderating role of corporate governance in the CPA-CFP relationship, following the recent trend in research to investigate non-direct links between nonmarket strategies and performance (Mellahi, 2016).
In order to carry out this research, this study addresses the following research questions: 1. How does corporate political activity affect firm performance?
2. How do measures of good governance affect corporate political activity? 3. Does good governance moderate the relationship between corporate political
5 | P a g e Our results unexpectedly show a positive relationship between corporate political activities and corporate financial performance, while good governance does seem to negatively influence corporate political investments, signaling agency problems. This indicates that firms with good governance invest less in corporate political activity, but that this is not necessarily a good thing for the firm, meaning that while managers might engage in corporate political activities because of self-interest, these interests are likely to be aligned with firm and shareholders interests.
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Theoretical background and hypotheses development
Corporate Political activity
Corporate political activity (CPA) is often defined as corporate attempts to manage political institutions and/or influence political actors in ways favorable to the firm (Baysinger, 1984, Hillman et al., 2004; Lux et al., 2011, Mellahi et. al., 2016). CPA can be seen as a component of firm non-market strategy (Baron, 1995, Lux et. al., 2011, Mellahi et. al., 2016). A firms non-market strategy is considered to be the firms effort to manage the institutional or societal context of economic competition (Boddewyn, 2003, Lux et. al., 2011). Scholars typically assume that firms engage in non-market strategies to enhance firm performance (Mitchell et. al., 1997, North, 1990), and the decision to engage in CPA is often conceptualized as an investment decision (Aggarwal, 2012); firms allocate resources to corporate political activity when they are expected to generate better returns than other investments (Lux et. al., 2011). Quite some research has been done towards the antecedents of CPA at different levels (Hillman et. al., 2004). Hillman et. al. (2004) mention four levels of antecedents, including firm-level, industry-level, issue-level and institutional-level antecedents.
Firm-level antecedents, the most relevant ones for this study, are the focus of scholarly work utilizing two different assumptions about firm decision processes (Hillman et. al., 2004). In accordance with non-market strategy literature (North, 1990), Hillman and colleagues notes that management scholars emphasize strategic choice, and assume that managers choose to engage in political activity to enhance firm value. These choices would largely depend upon firm specific factors as size, financial resources and government dependence (Hillman et. al., 2004). The second view relates to researchers from economics and political science, who adopt a profit maximizing approach (Mitchell et. al., 1997), assuming the firm is a black box
7 | P a g e that maximizes value and will automatically engage in corporate political activity when they have certain firm characteristics. However, even these scholars admit that organizations and managers have some amount of discretion over their selection of political activities (Caldeira et. al., 1000, Hillman et. al., 2004), allowing the possibility that managers can act in their own interests when it comes to corporate political investments.
CPA and Financial performance
‘A core assumption in most CPA scholarship is that firms engage in corporate political activity to improve performance’ (North, 1990, Mitchell et. al., 1997, Lux et. al., 2011). While scholars have only recently started empirically examining the relationship between CPA and performance (Lux et. al., 2011), most research has assumed CPA to be positively related to performance (Bonardi et. al., 2005, Hillman et. al., 2004, Lux et. al.). CPA may have direct and indirect effects on a firm’s financial performance (Hadani & Schuler, 2013); CPA may lead to direct results through securing government contracts or limiting the abilities of competitors to compete in the firms markets (Hadani & Schuler, 2013, while CPA can indirectly influence financial performance by shaping the public policy environment to reduce the effects of harmful regulations (Epstein, 1969). In their review of antecedents and outcomes of corporate political activity, Hillman et. al. (2004) identify three studies exploring the direct effect of CPA on firm financial performance (Marsh, 1998, Hillman et. al., 1999 , Shaffer et. al., 2000), all of them indicating a positive effect. Lux et. al. (2011) summarized CPA-performance research in their meta-analysis, and concluded that there is a positive relation between corporate political activities and performance as well. However, recent findings have provided new insights into the CPA - corporate financial performance
8 | P a g e relationship. Aggarwal (2012) found that corporate donating negatively effects firm future excess returns. Hadani & Schuler (2013) compare a combined value of CPA (using factor analysis) with firm market value, and also come to the conclusion that CPA negatively effects firm financial performance. Mellahi et. al. (2016), in their recent publication on the integration of non-market strategies as CPA and corporate social responsibility, analyzed articles studying the relationship between both concepts and firm financial performance, counting the amount of studies with positive, neutral and negative effects. They note that a majority of empirical studies towards CPA and performance report a positive effect (Mellahi et. al., 2016), with twenty studies reporting a positive effect, eleven studies reporting a neutral effect, one study reporting an insignificant effect and four studies showing a negative relation between corporate political activity and firm financial performance. While Mellahi et. al. (2016) recognize the majority of studies to identify a positive relationship, the amount of papers not finding a positive effect between nonmarket strategy and firm financial performance contributes to the ‘equivocality’ of the relationship. It should be noted that the ‘vote counting technique’ as used by Mellahi et. al. (2016), is highly criticized in academics (Hedges and Olkin 1980, Hunter and Schmidt , 1990, Rosenthal , 1995, Schmidt , 1992, Orlitzky et. al., 2003), noting that conclusions are likely to be false. (Hedges and Olkin ,1980, Hunter and Schmidt, 1990, Orlitzky et. al., 2003)
Authors have tried to explain the CPA-CFP relation using several theoretical frameworks. Hadani & Schuler (2013) hypothesize the relation between corporate political activity and firm financial performance using industrial economics theory, resource dependence theory, class unity theory, political marketplace theory and the behavioural theory of the firm. However, since they found a negative relationship between CPA and CFP, they mention agency problems as a possible explanation for this negative relationship. This same concern is expressed by Aggarwal (2012), who mentions agency problems as the main cause
9 | P a g e for corporate donations having a negative effect on firm future excess returns. Actually, years before, Hillman et. al. (2004) already identified managerial influence as a possible antecedent of CPA, as he found multiple studies indicating significant managerial discretion related to corporate political activity. For instance, Blumentritt (2003) found that ‘managerial orientation may be more important than the amount of bargain power resources owned’, while Cook and Barry (1995) note that they were ‘struck by how large a role subjective, cognitive elements played in influence processes related to CPA’. Following these recent indications, this study investigates the role of agency problems in corporate political activity. Therefore, we come up with the following hypothesis:
H1: Corporate political activity is negatively related to corporate financial performance.
Agency theory & Corporate Governance
Agency theory is all about the agency relationship, in which one party, the principal, delegates work to another party (the agent), who performs that work. Agency theory attempts to describe this relationship using the metaphor of a contract (Jensen & Meckling, 1976, Eisenhardt, 1989). Agency theory is concerned with solving two problems: the agency problem, that pops up when desires or goals of the principal and the agent conflict, and when it is difficult or expensive for the principal to control what the agent is actually doing (Eisenhardt, 1989). Agency theory assumes managerial self-interested behavior, managers pursue their own interests instead of those of the firms’ shareholders (Eisenhardt, 1989). Agency theory is among the most important conceptual/theoretical foundations that inform corporate governance research (Dalton et. al., 2007). The potential for mischief when the
10 | P a g e interests of managers and owners diverge (Dalton et. al., 1998) has resulted in the necessity of monitoring mechanisms, designed to protect the shareholders as owners of the firm (Fama & Jensen, 1983, Jensen & Mecklink, 1976, Dalton et. al., 2007). This monitoring direction is one of the primary duties of the board of directors (Fleischer et. al., 1988). Agents’ interests can be aligned with the principals’ through two sort of ways; a behavioural oriented contract and an outcome oriented contract (Eisenhardt, 1989). The amount of outcome measurability and task programmability defines which one is most viable (Ouchi, 1979). An example of behavior oriented contracts are governance structures, which are meant to align the interests of the agent with those of the principal. Dalton et. al. (1998) notes that there is a near consensus in the conceptual literature about board composition, a governance structure. They mention that effective boards will be compromised of outside directors (Lorsch & Young, 1989, Mizruchi, 1984, Zahra & Pearce, 1989). This statement is largely grounded in agency theory (Dalton et. al., 1998). As firm managers gain control in the firm, they might pursue actions that benefit themselves instead of the firm owners (Dalton et. al., 1998). Non- management directors are believed to provide superior performance benefits to the firm, since they are independent from firm management. This hypothesis is empirically supported by Baysinger & Butler (1985), Schellenger et. al.(1989), Pearce & Zahra (1992) and Ezzamel & Watson (1993). Outside directors would better be able to protect shareholders as owners of the firm, and therefore reduce agency problems. CPA has been indicated to be related to agency problems; firms that invest more in politics, are likely to have agency problems (Aggarwal, 2012). Hillman & Dalziel (2003) note that agency scholars argue that dependence on the CEO/organization creates a disincentive for insiders and dependent outsiders to pursue shareholders’ interests. Boards dominated by outsiders are thought to be better monitors of management, because they lack this disincentive to monitor (Hillman & Dalziel, 2003). According to Winter (1977), outside directors can ask questions even ‘a fully conscientious
11 | P a g e management may not face directly because of an unconscious pride of authorship’. Weisbach (1988) finds that the higher the proportion of outside directors on the board, the more likely it is that the board will replace the firm’s chief executive officer after a period of poor performance, signaling good monitoring Direct evidence of outside directors positive influence on shareholder wealth is provided by Rosenstein & Wyatt (1990), who show a positive stock price reaction at the announcement of the appointment of an outside director. Byrd & Hickman (1992) find that bidding firms with an outsider dominated board, have significantly higher announcement-date returns than other bidders. Baysinger and Butler (1985) note that independent outside directors represent the monitoring component of the board. Boards with a high percentage independent outside directors will approve fewer unprofitable acquisitions than other boards. According to Ricardo Campbell (1983) and Fama and Jensen (1983), outside directors have a greater incentive to monitor corporate decision on behalf of all shareholders, because they have invested significantly in establishing reputations as decision making experts. While opposing certain proposals and acquisitions in the board may jeopardize a directors position in the board, the cost of supporting a decision that negatively affects shareholders could still be greater, because it would reduce the directors reputational capital in the marketplace for decision experts.
A high percentage of inside directors would reduce the monitoring function of the board, increasing the possibility of agency problems. (Hillman & Dalziel, 2003). Assuming agency problems are indeed related to corporate political activity, a high amount of outside directors would improve the monitoring function of the board and therefore decrease money invested in corporate political activity. Based on aforementioned research, we expect outsider-dominated boards to be more critical towards corporate political investments. And since boards with a lot of outside directors are likely to have a superior monitoring function when compared to other boards, managers will be less likely to pursue their own interests and
12 | P a g e therefore invest less in CPA, that supposedly benefits their own ideological beliefs, desire to voice (Triphati et. al. (2002), and can increase compensation and job security (Coates, 2012, Hadani & Schuler, 2013). Therefore, we have come up with the following hypothesis:
H2: The amount of outside directors is negatively related to CPA
Agency theory is also applicable to other forms of board leadership structure (Dalton et. al., 1998). Finkelstein & D’Aveni (1994) note that according to agency theory, CEO duality (CEO being leader of both management and board of directors) reduces board monitoring effectiveness and therefore promotes CEO entrenchment. In accordance with this statement, Rechner & Dalton (1991) found that firms with a separation of ownership and control in board leadership, outperformed firms with a CEO that was both the leader of management and the board of directors. Advocates of the CEO duality structure argue that the combination of the CEO and chairman position provides a single focal point for company leadership; There would never be issues and questions about who is boss or who is responsible. The separation of the CEO and chairman position would produce chaos both within the organization and in relationships with the board (Anderson & Anthony, 1986, Rechner & Dalton, 1991). Baliga et. al. (1996) provide four arguments CEO give why a firm should have a CEO who is also the chairman of the board: non-duality would result in dilution of power to provide good leadership by increasing the probability that the actions and expectations of the management and the board are at odds with each other (Alexander et. al., 1993, Baliga et. al., 1996). Secondly, non-duality might result in a rivalry between the chairman and the CEO (Baliga et. al., 1996). Non-duality could also result in the existence of two public spokesman and limit innovation and intrapreneurship when the CEO feels that the board will keep second guessing his/her actions (Baliga et. al., 1996)
13 | P a g e Opponents of duality, however, argue that through serving as both chairman and CEO, the CEO will acquire a larger power base and locus of control (Hambrick & Finkelstein, 1987, Harrison et. Al., 1988, Patton & Baker, 1987), thereby weakening the decision control by the board (Morck et. Al., 1989, Boyd, 1995). The reduction in board power facilitates the CEO’s pursuit of his/her own agenda, which might substantially differ from shareholder interests (Boyd, 1995). Boyd (1995) argues that based on agency theory, the combination of the CEO and chairman function would weaken board control, and therefore negatively affect firm performance.
Combining the notions that CEO reduces the monitoring effectiveness of the board (Finkelstein & D’Aveni, 1994), signaling agency problems, and that CPA is indicated to be a product of agency problems (Aggarwal, 2012, Hadani & Schuler, 2013), we expect CEO duality to be positively related to corporate political activity. Firms with an ineffectively monitoring board might be more inclined to invest in corporate political activity, since there is less punishment for managers pursuing their own interests. Therefore, we come up with the following hypothesis:
H3: CEO duality is positively related to corporate political activity.
Another measure of good governance is the size of the board. Lipton & Lorsch (1992) note that while with an increase in the amount of board directors, the board capacities to monitor increase, these benefits are outweighed by costs as slower decision making, less candid discussions about managerial performance and a bias against risk-taking behavior. Jensen (1993) provides another downside of large boards of directors, stating that an increase in board size comes with a greater emphasis on politeness and courtesy in the boardroom, at the
14 | P a g e expense of truth and frankness. According to Jensen (1993), when boards would get beyond seven or eight people, it is less likely to function effectively and is more easy for a CEO to control. Building on the findings of Lipton & Lorsch (1992) and Jensen (1993), Yermack (1996) investigated the relation between the board size and firm value. He found an inverse association; as board size increases, firm value decreases. Yermack (1996) also notes that firm profitability and operating efficiency appear to decline, as board size increases. Large boards also implement less CEO performance incentives and threats of dismissals, indicating the larger CEO control of the board (Yermack, 1996). Eisenberg et. al. (1998) emphasize the importance of investigating the firm value/board size relation in small firms as well, as the results using a Fortune 500 sample (Yermack, 1996) might not extend to smaller firms or firms operating in different legal and cultural environments. Both Eisenberg et. al. (1998) and Mak & Kusnadi (2005) find an inverse relation between board size and firm performance (using measures as profitability) as well. However, this interpretation of the results is not undisputed. Guest (2009) points out a few papers (Lehn et. al., 2004, Boone et. al., 2007, Coles et. al., 2008, Guest, 2008, Linck et. al., 2008) who show that board size is determined by firm specific variables such as profitability, firm size and Tobin’s Q. Previous studies have been heaviliy criticized for not adequately controlling for endogeneity problems; poor performance could lead to an increase in board size (Eisenberg et. al., 1998, Guest, 2009). To address this problem, Guest (2008) uses Wintoki (2007)’s method to control for past performance, investigating the board size/firm performance relationship. Nevertheless, they also find a negative relation between board size and firm performance measures (Guest, 2008). Building on this research, we can conclude that smaller boards will reduce CEO’s control over the board, and increase the effectiveness of board decision making, resulting in significantly better firm performance. Since we assume corporate political activity to be
15 | P a g e agency-driven, and small boards of directors are known to be better monitoring devices when compared to larger boards, we expect the following statement to be true.
H4: Firms having larger boards of directors will invest more in corporate political activity when compared to firms with smaller boards.
Next to seeing corporate governance as a factor influencing the amount a firm invests in corporate political activity, Lux et. al. (2011) suggests that the relationship between corporate political investments and corporate financial performance can also be influenced by factors in a moderating or mediating role. Mellahi et. al. (2016) identifiy that scholars are no longer satisfied with identifying a direct link between nonmarket strategies and performance, noting that many scholars try to explore the underlying mechanisms through which corporate political strategies impact firm outcomes. Other studies also explore the moderating influences of various variables on the non-market strategy-firm performance relationship (Aguinis & Glavas, 2012;, Goll & Rasheed, 2004)
Mellahi et. Al. (2016), in their integrative framework of non-market strategies, propose that there are internal moderator mechanisms that moderate the non-market strategy-organizational performance relationship. They describe these mechanisms as ‘intra-organizational moderators reflecting the degree of agency conflicts and managerial opportunism. Mellahi et. al. (2016) explain that the role of agency theory in understanding how managerial factors moderate the performance effects of nonmarket strategies is of particular importance. They note that other theories explaining nonmarket strategies assume away the heterogeneity of agency concerns within business organizations. Mellahi et. al. (2016) emphasize that it are top managers who make strategic decisions and exercise agency in firm’s market and nonmarket environments. They argue that the degree of managerial
16 | P a g e opportunism in undertaking nonmarket activities serves as a crucial moderating mechanism to regulate performance effects of strategic CPA.
As good governance variables reflect the degree of agency conflicts and managerial opportunism (signaling the quality of the monitoring and control function of the board) study will follow this trend and examine the moderating role of good governance variables on the corporate political activity-corporate financial performance relationship. We expect that firms with good governance might be better equipped to deal with self-interested managers, and put managers to only submit CPA related proposals that benefit both the firm and the manager; moderating the relationship between corporate political activity and corporate financial performance.
H5: Good governance moderates the CPA-CFP relationship positively; good governance positively influences the effect of corporate political activity on corporate financial performance
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Data and methods
Our overall sample population is based on large firms headquartered in the United States of America over the period 2012-2015. To select our sample, we identified all companies that have been part of the Fortune 500 list over these years. All firms that were a part of this list between 2012 and 2015, were selected in our sample. By applying these criteria, we make sure that the firms in our study are comparable in size and location, and were active over the period examined. The abovementioned filtering resulted in a sample of 593 large American companies. Firm-level data were gathered with a group of motivated students that are all part of the Strategy-CSR/CPA group. CEO name and Firm headquarter were derived from the Fortune 500 list. Data on lobbying and donations were gathered from the Opensecrets.org database, America’s premier source of tracking the relation between money and politics.
Dependent variables
ROE: We use Return on Equity (ROE) as a measure of firm performance, since it is the most used measure of corporate performance by investors and analysts (Hagel et. al., 2010). LOBEXP: As a second dependent variable, we use lobbying expenditures. We gathered the total lobbying expenditures of our sample of companies between 2012-2015 from the Center of Responsive Politics. Than we averaged those numbers, to get a more robust measure of lobbying expenditures.
PAC: PAC contributions are measured as the average PAC donations of the sampled organizations over the years 2012-2015, derived from the American Center of Responsive Politics.
CPASUM: Aggregated amount of firm lobbying expenditures and PAC contributions, based on the cumulative CPI variable in Hadani & Schuler (2013).
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Independent variables
We measure Corporate political activity using five different measures; Lobbying expenditures, PAC contributions (also used as dependent variables) , amount of issues lobbied for, amount of lobby reports and amount of lobbyists hired by the firm. Two of the above mentioned variables are also used as a dependent variable and are already explained. It is very likely these measures form one factor, based on the exploratory factor analysis of Hadani & Schuler (2013).
Lobbyists: The amount of lobbyists hired by firms within our sample, derived from the Center of Responsive Politics. Amount of lobbyists from 2012 to 2015 were added up and divided by four.
Issues lobbied for: Firms hire lobbyists to lobby on different themes and issues. The Center of Responsive Politics has identified 81 different issues where firms can lobby for. This variable is the amount of issues lobbied for (Firms can be very specialized in their lobbying, or have a broader scope). These numbers are also averaged over the years 2012-2015.
Amount of lobby reports: Comparable to the variable ‘issues lobbied for’, lobbying firms file reports related to their lobbying issues. This variable measures the amount of reports filed per issue lobbied for.
Outside directors: We measured outside directors using data from the Thomson Reuter ESG database. Outside directors were measured as a percentage of strictly independent board members, who were not employed by the company; not representing or employed by a majority shareholder; not served on the board for more than ten years; not a reference shareholder with more than 5% of holdings; no cross-board membership; no recent , immediate family ties to the firm and not accepting any compensation other than compensation for board service. The percentages of outside directors from 2012-2015 are added up and divided by four, to provide a robust average number.
19 | P a g e CEO Duality: The data for CEO Duality has also been derived from the Thomson Reuter ESG database. CEO duality is measured as a dummy variable, signaling if the CEO is simultaneously the chair of the board of directors and has the chairman of the board been CEO of the company. The variables from 2012-2015 are added up and divided by four to, to get a robust average.
Board Size: The data for Board Size has been derived from the Thomson Reuter ESG database. Board size is measured as the total number of board members, at the end of the fiscal year. To come up with a robust average, the amount of board members per firm between 2012 and 2015 are added up and divided by four.
Control variables
Firm Size: To control our analyses, we use two different measures of firm size, as Firm size is indicated to influence corporate political investments (Hillman et. al., 2004). We use two different measures of firm size: size by employees and size by revenue. The Log value of these variables is taken from the years 2012-2015, and divided by four to provide an average. GovDep: Government dependence variable, based on the one hundred biggest defense
contractors of the United States (Schuler et. al., 2002)
Analysis
The final dataset is unbalanced because it contains firm data with varying degrees of year observations. To solve this problem (as mentioned in the description of variables), all data (2012-2015) is averaged and analyze using cross-sectional analysis. Based on Green’s (1991) rule of thumb of acceptable sample size, our sample is fine to perform a regression analysis (50+(8*6) = 98). We checked all data for normality, linearity and homoscedasticity.
20 | P a g e We start the analysis with a principal component factor analysis, to see if the measures of corporate political activity are related to each other and can be combined. Afterwards, we will conduct regression analyses to investigate the relationship between corporate political activity and firm performance. The second and third regressions will be about the relationship between corporate governance and two measures of corporate political activity: Lobbying expenditures and PAC contributions respectively. Then, we will investigate the moderating role of corporate governance in the CPA-firm performance relationship, using the PROCESS application for SPSS by Andrew Hayes, which is fit to investigate moderating and mediating relationships. Before executing this model, we centralized the independent and moderating variables, following the statistics guide of Twente University.
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Results
Table 1 shows the descriptive statistics of the most used valuables in this study. Our sample contains 528 measures of most variables, while CEO duality has the least amount of available values of the sample with 409 values. We checked the variables for normality (Appendix A), linearity (Appendix B) and homoscedasticity.
Table 1: Descriptive Statistics
N Minimum Maximum Mean Std. Deviation
ROE 528 -12,252 20,915 ,24093 1,623977 LOBBYISTS 528 ,00 153,75 13,3636 19,80586 PAC 528 ,00 3087563,50 212953,2585 384044,49380 LOBEXP 528 ,00 18946250,00 1781438,8840 2955675,44100 BRDINDEP 528 ,00 87,91 38,8737 21,32253 BRDSIZE 428 4,25 18,75 11,0146 1,93027 CEODUALITY 409 ,00 1,00 ,7231 ,39823 Valid N (listwise) 409
Table 2 reports the outcome of a principal component factor analysis. We conduct this analysis, to see if the corporate political activity concept can be measured in scales. There are four factors with eigenvalues above one, with some variables to be related unexpectedly. All factors have a high relatively high convergent validity (Tabashnick & Fidel, 2001), indicating that the scales positively correlate with other measurements of the same construct. The discriminant validity of the measures is also very high, with the exception of firm size based on revenue.
The factor analysis shows that the first factor explains the variation in measures of corporate political activity very well, with most scores over .90. This means corporate political activity can be combined in one scale, as has been done by Hadani & Schuler (2013). Table two shows the KMO and Bartlett’s test, which measures the factorability and non-identity of R. The KMO score of .833 is above the threshold of .80 and the Bartlett’s test is significant, which means the factor analysis is adequate (Tabashnick and Fidel, 2001), and a cumulative CPA variable can be formed to conduct an analysis with corporate governance as a moderating variable.
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Table 2: Rotated Component Matrixa
Component 1 2 3 4 LOBBYISTS ,946 ,145 ,029 ,004 REPORTS ,940 ,121 -,004 ,046 ISSUES ,939 ,123 -,006 ,039 REVLOB ,937 ,147 ,031 -,009 CPASUM ,924 ,178 ,072 -,018 LOBEXP ,913 ,177 ,069 -,019 PAC ,812 ,151 ,085 -,007 SIZEEMP ,223 ,729 ,124 ,302 SIZEREV ,534 ,597 -,045 ,236 BRDDIVERS ,048 ,591 ,063 -,176 BRDSIZE ,210 ,550 -,087 -,148 CEODUALITY ,068 -,006 ,662 -,018 TOBINSQ -,084 ,210 ,629 -,173 ROE ,113 -,100 ,567 ,123 BRDINDEP ,165 -,009 -,102 -,723 GOVDEP ,152 -,075 -,130 ,630 Extraction Method: Principal Component Analysis. Rotation Method: Varimax with Kaiser Normalization.a
a. Rotation converged in 6 iterations.
Table 3: KMO and Bartlett's Test
Kaiser-Meyer-Olkin Measure of Sampling Adequacy. ,849 Bartlett's Test of Sphericity Approx. Chi-Square 4655,768 df 55 Sig. ,000
23 | P a g e We run four models, using three different dependent variables: a control model (1), a model with CPA and CFP (2), two models with and corporate governance measures and measures of CPA and a model with CPA and CFP with CG as a moderator (3)
Our first hypothesis concerns the relationship between CPA and firm financial performance. The hypothesis predicts a negative relationship between corporate political activity and firm financial performance. We find that CPA is significantly correlated with firm financial performance on measures of lobbying expenditures, PAC contributions and the amount of lobbyists (Appendix D). However, the effects of corporate political activity are small, and the R-value of the regression is only .148 (Table 4). Most notably, only the effect of PAC on corporate financial performance is statistically significant (at the 0.10 level, a significance of .051), and positive (Table 5). This contradicts the first hypothesis of this study.
24 | P a g e Regression 1
Table 4 : Model Summaryb
Model R R Square Adjusted R Square Std. Error of the Estimate Change Statistics Durbin-Watson R Square Change F Change df1 df2 Sig. F Change
1 ,148a ,022 ,009 1,616980 ,022 1,653 7 520 ,118 1,995
a. Predictors: (Constant), SIZEEMP, DUMMYGOVDEP, LOBBYISTS, PAC, LOBEXP, ISSUESLOB, REPORTSSLOB b. Dependent Variable: ROE
Table 5: ANOVAa
Model Sum of Squares df Mean Square F Sig. 1 Regression 30,253 7 4,322 1,653 ,118b
Residual 1359,604 520 2,615 Total 1389,857 527
a. Dependent Variable: ROE
b. Predictors: (Constant), SIZEEMP, DUMMYGOVDEP, LOBBYISTS, PAC, LOBEXP, ISSUESLOB, REPORTSSLOB
25 | P a g e Table 6: Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig.
Correlations Collinearity Statistics
B Std. Error Beta Zero-order Partial Part Tolerance VIF
1 (Constant) ,094 ,192 ,488 ,625 LOBBYISTS ,011 ,011 ,132 1,020 ,308 ,090 ,045 ,044 ,113 8,882 LOBEXP 4,940E-9 ,000 ,009 ,095 ,924 ,092 ,004 ,004 ,212 4,725 PAC 5,692E-7 ,000 ,135 1,960 ,051 ,131 ,086 ,085 ,399 2,507 ISSUESLOB -1,680E-5 ,012 ,000 -,001 ,999 ,068 ,000 ,000 ,035 28,582 REPORTSSLOB -,005 ,008 -,161 -,648 ,517 ,065 -,028 -,028 ,030 32,927 GOVDEP -,128 ,201 -,028 -,634 ,526 -,027 -,028 -,028 ,981 1,020 SIZEEMP ,059 ,137 ,020 ,432 ,666 ,060 ,019 ,019 ,845 1,184
26 | P a g e Our second , third and fourth hypothesis are about the relation between good governance and corporate political activity. Here, we executed two regressions with lobbying expenditures and PAC contributions as dependent variables, explained by measures of good governance. Both regressions show a high predictive value (R of .616 and .569 respectively, Table 7 & 10). The second hypothesis predicts the amount of outside directors to be negatively related to corporate political activity, which is not the case. A one percent increase in board independence, results in a 23842.42 dollar increase in lobbying expenditures(table 9). This effect is significant at the 0.05 level. The same counts for PAC contributions; a one percent increase in board independence results in a 3326, 42 dollar increase in PAC spending, also significant at the 0.05 level (Table 12). Therefore, the second hypothesis is rejected. The third hypothesis predicts CEO duality to be positively related to corporate political activity, which we found is true. When the CEO of a firm is also the director of the board, on average, a firms spends over six hundred thousand more on lobbying (Table 9), and contributes more than a hundred thousand more to PACS (Table 12). These effects are both highly significant (0.05 level), and therefore, the third hypothesis is accepted. Hypothesis 4 suggests a positive relation between board size and corporate political activity. This hypothesis receives clear support, as every extra member in the board of directors results in a 174534 increase in lobbying expenditures (Table 9) and a 107774 increase in PAC contributions (sign < 0.05, Table 10)
27 | P a g e Regression 2, DV: Lobbying expenditures, IV: Corporate governance variables
Table 7:Model Summaryb
Model R R Square Adjusted R Square Std. Error of the Estimate Change Statistics Durbin-Watson R Square Change F Change df1 df2 Sig. F Change
1 ,616a ,379 ,368 2470866,01800 ,379 34,977 7 401 ,000 1,854
a. Predictors: (Constant), DUMMYGOVDEP, CEODUALITY, BOARDSIZE, BOARDINDEP, BOARDDIVERS, SIZEEMP, SIZEREV b. Dependent Variable: LOBEXP
Table 8.: ANOVAa
Model Sum of Squares df Mean Square F Sig. 1 Regression 14947974820000 00,000 7 21354249750000 0,000 34,977 ,000b Residual 24481767300000 00,000 401 6105178879000, 000 Total 39429742130000 00,000 408
a. Dependent Variable: LOBEXP
b. Predictors: (Constant), DUMMYGOVDEP, CEODUALITY, BOARDSIZE, BOARDINDEP, BOARDDIVERS, SIZEEMP, SIZEREV
28 | P a g e Table 9 :Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig.
Correlations Collinearity Statistics
B Std. Error Beta Zero-order Partial Part Tolerance VIF
1 (Constant) -19407164,130 1499534,037 -12,942 ,000 BOARDSIZE 174534,325 72603,042 ,101 2,404 ,017 ,274 ,119 ,095 ,885 1,130 CEODUALITY 612587,318 309628,188 ,078 1,978 ,049 ,110 ,098 ,078 ,984 1,016 BOARDDIVERS 12064,254 15452,701 ,032 ,781 ,435 ,171 ,039 ,031 ,925 1,081 BOARDINDEP 23842,421 8063,454 ,118 2,957 ,003 ,111 ,146 ,116 ,971 1,030 SIZEEMP -288034,981 312050,598 -,047 -,923 ,357 ,344 -,046 -,036 ,587 1,704 SIZEREV 4345975,038 404075,826 ,564 10,755 ,000 ,584 ,473 ,423 ,563 1,775 GOVDEP 741456,539 354923,980 ,083 2,089 ,037 ,133 ,104 ,082 ,974 1,027
29 | P a g e Regression 3, DV : PAC contributions, IV: Corporate Governance Variables
Table 10 : Model Summaryb
Model R R Square Adjusted R Square
Std. Error of the Estimate
Change Statistics
Durbin-Watson R Square Change F Change df1 df2 Sig. F Change
1 ,569a ,323 ,311 343907,73480 ,323 27,359 7 401 ,000 2,030
a. Predictors: (Constant), GOVDEP, CEODUALITY, BRDSIZE, BRDINDEP, BRDDIVERS, SIZEEMP, SIZEREV b. Dependent Variable: PAC
Table 11 : ANOVAa
Model Sum of Squares df Mean Square F Sig. 1 Regression 22650461800000 ,000 7 3235780258000, 000 27,359 ,000b Residual 47427284550000 ,000 401 118272530100,0 00 Total 70077746360000 ,000 408
a. Dependent Variable: PAC
b. Predictors: (Constant), GOVDEP, CEODUALITY, BRDSIZE, BRDINDEP, BRDDIVERS, SIZEEMP, SIZEREV
30 | P a g e Table 12 : Coefficientsa Model Unstandardized Coefficients Standardized Coefficients t Sig. Correlations
B Std. Error Beta Zero-order Partial Part
1 (Constant) -2356336,901 208712,796 -11,290 ,000 BRDSIZE 24051,605 10105,262 ,104 2,380 ,018 ,260 ,118 ,098 CEODUALITY 107774,102 43095,630 ,104 2,501 ,013 ,132 ,124 ,103 BRDDIVERS -1714,509 2150,786 -,034 -,797 ,426 ,102 -,040 -,033 BRDINDEP 3326,431 1122,313 ,124 2,964 ,003 ,109 ,146 ,122 SIZEEMP 5597,458 43432,794 ,007 ,129 ,898 ,343 ,006 ,005 SIZEREV 509709,302 56241,334 ,496 9,063 ,000 ,536 ,412 ,372 GOVDEP 54508,827 49400,130 ,046 1,103 ,271 ,088 ,055 ,045
31 | P a g e Next, we examine the moderating role of corporate governance on the CPA-CFP relationship. We found that corporate governance does not moderate the CPA-CFP relationship. Table 13 shows that the model is insignificant (p: .4473) and that none of the governance variables moderate the relationship between the cumulative variable of CPA and corporate financial performance (P values all above 0.05, Table 14). These findings contradict our expectation that good governance moderates the CPA-CFP relationship.
32 | P a g e
Table 3: CPA-CFP, CG as moderator
Table 13: Model Summary, outcome ROE
R R-sq MSE F Df1 Df2 p
,1282 ,0164 3,3594 ,9518 5,0000 403,0000 ,4473
Table 16: Indirect effect of X on Y
Effect Boot SE Boot LLCI Boot ULCI
Total -.0017 0.212 -.0530 .0344 ZCEODUAL .0114 .0079 .0008 .0347 ZBRDDIVE .0074 .0146 -.0164 .0444 ZBOARDSI -.0110 .0175 -.0536 .0184 ZBOARDIN -.0096 .0094 -.0396 .0014 Table 14 : Model
Coeff Se T P LLCI ULCI
constant .3087 .1488 2.0742 .0387 .0161 .6014 ZCEODUAL .1042 .0612 1.7018 .0896 -0.0162 .2246 ZBRDDIVE .0563 .1061 .5309 .5958 -.1523 .2650 ZBOARDSI -.0445 .0684 -.6513 .5152 -.1789 .0899 ZBOARDIN -.1328 .1055 -1.2592 .2087 -3401 .0745 ZCPASUM .1757 .1942 .9050 .3660 -.2060 .5574
Table 15.: Direct effect of X on Y
Effect SE T P LLCI ULCI
33 | P a g e
Discussion
Hadani & Schuler (2013) compare the belief that political investments by firms pay off to the sixteenth century quest for El Dorado, the legendary city of Gold, which ended disastrously for multiple groups of adventurers. Hadani & Schuler (2013) point out that, as with the aforementioned explorers, their efforts are not likely to materialize.
Multiple theories try to explain the corporate political activity, for instance resource dependency theory, class-unit theory, industrial organization economics, political marketplace theory and the behavioural theory of the firm (Hillman et. al., 2004, Hadani & Schuler, 2013). Recently, there has been a stream of research that critically assessed the assumption that corporate political activity positively affects corporate financial performance (Lux et. al., 2011, Aggarwal, 2012, Hadani & Schuler, 2013, Ozer & Alakent, 2013). These authors have suggested agency theory to have the most explanatory value concerning corporate political activity. Managers would engage in corporate political activity because of their own ideological beliefs, desire to voice (Tripathi et. al. (2002), increased compensation and job security (Coates, 2012, Hadani & Schuler, 2013). Building on the indications that agency problems are involved with CPA, this study examined the role of corporate governance in the CPA-CFP relationship, taking into account that various corporate governance variables have been shown to mitigate agency problems (Aggarwal, 2012). However, the results of this study do not support the expectation that corporate political activity is negatively related to corporate financial performance. While the relation between CPA and CFP is statistically significant, the effects are small and largely positive. This contradicts the recent findings of Aggarwal (2012) and Hadani & Schuler (2013). Reasons for the difference in results with Aggarwal (2012) might be that this research included more measures of corporate political activity which are indicated to be positively related to performance (Mathur & Singh, 2012). Next to that, our data is more up-to-date when compared to these two studies, with Aggarwal
34 | P a g e (2012) and Hadani & Schuler (2013) studying samples from 1991-2004 and 1998-2008 respectively.
In accordance with Lipton & Lorsch (1992), Jensen (1993) and Yermack (1996), we expected large boards to result in increased CPA spending, as large board would be ineffective in constraining agency problems. The results show that large board do indeed results in higher political spending, indicating agency problems. The same goes for CEO duality, where a firm with a CEO who is also the chairman of the board does spend significantly more on corporate political activities. Both these results do point in the direction of agency problems. Our study shows that an increase in outside directors does not result in decreased corporate political activity. However, a high amount of outside directors is the most controversial measure of good governance in this study, as Hadani & Schuler (2013) point out that the placement of external public officials does not increase board effectiveness.
Therefore, the indication of agency theory as an explanatory theory for corporate political activity does have some ground. But, the conclusions of this stream of research that agency problems are the underlying cause of a negative relationship between corporate political activity and corporate financial performance are highly doubtful. Recent meta-analysis (Mellahi et. al., 2016) does also not support the view that CPA and CFP are negatively related. The results of this research do also not support the hypothesis that corporate governance moderates the CPA-CFP relationship, as the CPA does not influence CFP significantly different taking good governance into account.
This study makes two main contributions to theory. First, this study contributes to the growing body of research empirically assessing the relationship between non-market strategies and firm performance. Mellahi (2016) points out the relevance of this discussion, especially since the assumed positive CPA-CFP relationship is not uncontroversial anymore (Aggarwal, 2012, Hadani & Schuler, 2013). This research shows that although the effects are
35 | P a g e small, corporate political activity still positively affects corporate financial performance. Since our results show that the CPA-CFP relationship is not necessarily negative, this also opens up for other theories to explain this relation. Hadani & Schuler (2013) categorized different theories on their prediction of the CPA-CFP relationship, providing only agency theory as an explanation for his findings that implicate a negative relationship. Finding out that the CPA-CFP relationship is not necessarily negative, theories that predicted a positive and neutral relationship, like industrial economics theory, resource dependence theory, class unit theory, political marketplace theory and the behavioral theory of the firm, might be more valuable to explain CPA than Hadani & Schuler (2013) suggest.
The second theoretical contribution of our research should receive some extra attention. Bad governance (CEO duality and large board) does result in increased corporate political activity, while CPA is not negatively related to corporate financial performance. This indicates that firms with good governance invest less in corporate political activity, which does not necessarily result in increased firm performance. Chaney et. al. (2010) and Yu and Yu (2011) show that CPA increases information asymmetry between management and shareholders. This, combined with the dubious reputation of corporate political engagement, might cause members of the board to be reserved towards CPA. However, CPA does seem to be positively related to corporate financial performance, with only the amount of issues lobbied for to be negatively related. This means that while managers might engage in corporate political activities because of self-interest, these interests are likely to be aligned with firm and shareholders’ interests.
In her well known article about agency theory, Eisenhardt (1989) notes that agency theory provides a unique, realistic and empirically testable perspective on ‘problems’ of cooperative effort. One of the most important theoretical contributions of this paper, is that what might seem as a conflict of interest (problem) between principal and agent, can work out
36 | P a g e fine for both of them in case of a complex investment like CPA. Good boards seem to limit corporate political investments, while they are responsible for acting in the best interest of the firm’s shareholders. As corporate political investments are complex and the outcomes of these investments are not very clear, boards might be inclined to reject investments in CPA. Managers might even commit themselves to CPA out of fully conscious self-interested behavior. But, considering the complexity of CPA outcomes, it might be better for the board and the shareholders of the firm to let the manager act in his own self-interest, which can in turn lead to increased firm performance. These findings call for a broader view of agency theory; since some (non-market) strategies have complex outcomes, what seem to be agency problems can actually work in favor of the firm. Agency theory is about the costs that arise through moral hazard and adverse selection (Eisenhardt, 1989), but these results indicate that agency problems can result in profit instead of costs.
Limitations
As we used a sample of Fortune 500 firms in America, this research has a limited generalizability. Small firms for example, do often not have the resources to invest in corporate political activity, while the customs around corporate political activity can also be very different outside of the United States. Another limitation is the unavailability of firm soft money contributions, data that Aggarwal (2012) and Hadani & Schuler (2013) did make use of. The use of quantitative data also comes with some limitations, as some authors note that in this field of research, the reliability on secondary data is to high (Lux et. al., 2011)
Future Research
The results from this study contradict the recent stream of research that shows CPA to have a negative relationship with firm financial performance. However, it is not unlikely that agency
37 | P a g e problems are involved with corporate political activity, as good governance does reduce corporate political investments in both lobbying and PAC contributions. Therefore, it would be very interesting to dive into the managerial decision making surrounding CPA, using qualitative methods. In CPA research, there has been a call for other sorts of methodology, since the reliance on secondary data is perceived to high (Lux et. al., 2011). The difficulty of collecting primary data is likely to contribute to the lack of stronger support for current theoretical perspectives (Lux et. al., 2011). Taking into account the large set of available data, many CPA hypotheses can be tested without ever leaving the office (Lux et. al., 2011). To provide new insights into the field of CPA, Hadani & Schuler (2013) propose that authors move away from publicly available information and instead conduct interviews and surveys with firms. Lux et. al. (2011) also propose the increased use of field research, utilizing surveys and interview methods. Since these would likely result in insightful findings (Lux et. al., 2011), authors should investigate corporate political activity by conducting interviews and case-studies. While Lux et. al. (2011) rightly point out that this method is underused because of the sensitivity of the subject, the growing acceptance of CPA among the media and general public (Lux et. al., 2011) may overturn management and board members’ concerns over participating in this study. Conducting such a qualitative approach to managerial decision making in CPA would answer the call of Hillman and colleagues (2004), who argue that surveys and interview could be used to gather information about how the political inclination, orientation and other such factors about top management influence firm’s corporate political activity (Hillman et. al., 2004).
On top of that, we see that not a single theory can adequately explain the complex concept of corporate political activity on its own (Lux et. al., 2011). Therefore, we praise authors like Mellahi et. al. (2016) and Hond et. al. (2014) who endeavor to integrate theories and concepts in order to get a better understanding of corporate political activity. We
38 | P a g e recommend authors to follow the same path and urge scholars to integrate existing theories to improve knowledge on the corporate political activity, specifically in its relation to corporate financial performance.
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