Seema Jayachandra’s paper (here is what appears to be the final draft, later published in the Journal of Law and Economics) examines what she calls the “Jeffords Effect”: the change in the value of politically connected firms in conjunction with the unexpected change in Senate control that came with Vermont senator James Jeffords’ departure from the Republican Party. She documents that firms that donated to the Republican Party lost almost 1% of their value in the week after Senate control unexpectedly shifted, while firms that supported Democrats gained almost half of a percent.
As Jayachandra notes, her findings provide strong evidence that many firms’ value is strongly affected by which party is in power, and that firms on average contribute more money to the party that is more favorable to their interests. What is not clear from the association between political control and the market value of donor firms is whether the firms gave money in order to get their preferred party in power or, instead, whether they gave money to buy favors politicians in the recipient party. To me, the most intriguing thing about the paper (once the careful empirical work of showing the association between donations and abnormal returns is out of the way) is the back-of-the-envelope calculations Jayachandran uses to assess these alternative interpretations of corporate soft money contributions. I’ll relate that logic here.
As a starting point, she estimates that $1 in soft money contributions bought roughly $46 in market capitalization in the Jeffords episode. (The actual gain was more like $2300, but she reasonably cuts this down by 50 because the soft money was only part of a contribution pattern that occurred over a longer period of time and included other forms of contributions.) If the Jeffords event were known in advance, this would be some seriously easy money and firms should have given a lot more. But it was not known in advance; political contributions here as elsewhere were a risky investment with uncertain outcomes. So Jayachandran looks at how risky of an investment it was under different possible motivations for giving.
If firms gave money in order to help their favored party get elected (in other words, if the Jeffords event was significant because it handed power to the Democrats), the probability of being “successful” (ie providing the contribution that would tip the scales and get your party into office) was very low. Jayachandran uses .01 percent as a rough estimate of the probability of our contribution tipping the scales, but of course it must be much lower than this. Given that the benefit of party control is estimated at $46 per dollar contributed, the low probability of success makes this form of investment very unattractive indeed. If this were the motivation, it would be a puzzle why any firm contributes at all.
If instead firms gave money in order to curry favor with one or the other party in anticipation of getting legislative benefits when that party is in power, the investment starts to look a lot better. The probability of your party being in power after the 2000 elections was about .5; even if there is some uncertainty about whether that party can come through with favors the probability of that the investment is a success (and thus that the $46 on the dollar is collected) is quite high. At this ROI the puzzle is why firms don’t contribute much more.
Jayachandran resolves this puzzle by arguing that only a small part of the Jeffords reflects the quid pro quo postulated in the second explanation above. If 99% of the jump in market value of Democrat-supporting firms came about because a party with a favorable ideology came to power, and only 1% because bought politicians are coming to power, then the ROI from currying favor with politicians would be a much more reasonable 12%. This makes sense to me.
If this is true, then most of the variance in market value reaction to the Jeffords event should depend on industry (ie whether the industry is favored by Democratic or Republican policy) and a small amount should depend on the firm’s own political contributions. Indeed, columns 3-6 of Table 5 (in the published version) include industry fixed effects and find no effect of firm giving on market value. She interprets this as saying that “between-industry variation in donations and returns” accounts for much of the power of the main results. This is statistically accurate, but in this setting the donations are really standing in for something else — the correspondence of an industry’s political donations and the ideology of the parties. The complete story, it seems to me, is that
- firms make soft-money donations almost entirely in order to curry favor with already-sympathetic legislators (or get them into office — an issue not addressed here), not to affect which party is in power;
- industry-level donations therefore mirror the underlying correspondence between industry interests and party platforms; and
- the Jeffords effect mostly reflects the fact that industries were differentially affected by the shift in political control.
In that sense the paper’s main result — the firm-level relationship between soft-money donations and stock price movements during the week of Jeffords’ defection — is almost completely an artifact of industry-level interests. I don’t mean to sound dismissive of the paper, because I think it’s outstanding, careful work, but I do come away thinking that Jayachandran didn’t quite follow her own evidence through to its logical conclusion.