We examine the relation between corporate liquidity and political connections measured via lobbying expenditures. This is an interesting question as many of the motives for holding cash should be diminished by political connections. Results indicate a significant and inverse relation between cash levels and lobby expenses and that the marginal value of cash decreases with lobbying. Taken together, these findings suggest firms react optimally to the reduced benefits of cash linked to political connections and that the market recognizes the weakened benefits of cash. Overall, our research shows another way political connections can shape corporate policy.
This is a preview of subscription content, log in to check access.
Buy single article
Instant access to the full article PDF.
Price includes VAT for USA
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
This is the net price. Taxes to be calculated in checkout.
Specifically, Faccio (2006) shows political connections increase value for a cross-section of international firms. Goldman et al. (2008) find that politically connected board members lead to increased value. Evidence presented by Fisman (2001), Faccio and Parsley (2007), Chen et al. (2009), and Hill et al. (2010) also show results consistent with political connectedness increasing firm value.
Lobbying activity is defined as the practice of attempting to persuade legislators to propose, pass, or defeat legislation or to change existing laws, which could provide gains for special interests. See www.senate.gov for a full discussion of lobbying activity.
Recent growth in lobbying expenditures indicates the increasing importance of lobbying to US firms and industry groups as a means to become politically connected. Total lobbying expenditures increased from $1.45 billion to $2.6 billion over the 1998–2006 period, a seventy-nine percent increase. Over this same period the number of registered lobbyists increased dramatically from 10,693 in 1998 to 15,247 in 2006. See the following link for more details: http://www.opensecrets.org/lobby/index.php.
Chung (1999) discusses various aspects associated with corporate lobbying strategies.
We note that the Faccio (2006) definition of political connectedness is only able to categorize US firms as politically connected based on whether a large shareholder or top officer is closely related to a top politician or party, as top-level US government officials are not allowed to be large shareholders or top officers.
Yu and Yu (2008) state that over half of former congressmen or senators become corporate lobbyists.
This difference in magnitude is also noted by Milyo et al. (2000), Anolabehere et al. (2002, 2003), and Yu and Yu (2010).
We emphasize that the focus of our paper concerns the relation between cash and political connections while Caprio et al. (2008) examine the association between cash and political corruption for international firms.
Their results also show that net working capital and capital expenditures have decreased and that research and development expenditures have increased over their sample period.
Also, improved financial performance will reduce financing frictions by reducing default risk. In turn, the demand for cash would be further weakened.
Other studies examine the market value of cash with respect to various corporate issues. Pinkowitz et al. (2006) show political corruption reduces the marginal value of cash for international firms, while Dittmar and Mahrt-Smith (2007) show weakened governance reduces the value of cash for US firms. Klasa et al. (2008) show the value of cash decreases with increased unionization rates. Finally, Tong (2009) shows that the marginal value of cash decreases with firm diversification.
We use this approach instead of 2SLS as Hill et al. (2010) show that cash and lobbying activity are influenced by similar factors making it difficult to find an exogenous regressor to use in the first-stage regression. Specifically, the authors show that corporate lobbying activity is related to size, growth opportunities, research and development expenditures, and industry affiliation, each of which appear in the OPSW framework (Eq. 1).
One of the primary components of NWC is trade payables, which provides another source of financial flexibility, complementing cash holdings. See Garcia-Teruel and Martinez-Solano (2010) for an excellent discussion of the benefits and costs of using supplier financing as a means of financial flexibility.
We use a trailing cash flow volatility measure calculated as follows. For observations in 1998 (first usable sample year), we require at least five panel appearances over the 1987–1997 sample period. We extend the estimation window for later years and maintain the five appearance minimum. For example, the estimation window for 2005 is 1987–2004. This methodology yields a time-variant yet backwards looking cash flow volatility without sacrificing too many observations..
Several studies use variations of the framework to value corporate liquidity. Pinkowitz et al. (2006) use the model to value cash held by international firms, while Pinkowitz and Williamson (2007) and Drobetz et al. (2010) use the model to value cash holdings for U.S. firms. Dittmar and Mahrt-Smith (2007) and Fresard and Silva (2010) use the framework to value excess cash holdings for US firms and US cross-listings, respectively. The model is a variant of the valuation framework developed by Fama and French (1998) to value the tax implications of dividends and debt. Lee (2010) uses the Fama and French (1998) model to examine the impact of managerial entrenchment on the market value of dividends.
The marginal effect of cash on firm value is calculated by taking the partial derivative of the regression equation with respect to cash. Since market value and cash are scaled by net assets, β 1 represents the change in market value for an additional $1 held in cash. Accordingly, β 7 represents the marginal impact of political connections on the market value of cash.
As shown in Table 4, we condition cash on other lobbying measures.
The database has a few of the nuances. Firms are required to submit good faith estimates, rounded to the nearest $20,000, of all lobby expenses for each six month period. Firms spending less than $10,000 in a six month period do not have to state lobby expenses, and the CRP treats their lobby expenses as $0. Also, the CRP attributes subsidiary lobby expenses to the parent firm. The CRP provides annual lobbying expenses by summing the mid-year and year-end reported lobbying expenditures.
To check for reporting errors, the Senate’s Office of Public Records matches lobby expenses reported by firms to revenues reported by lobbyists. The lobbying data reported by the CRP does not include amounts spent on industry trade association lobbying and so is considered an estimate of direct firm-level lobby expense. Thus, lobbying expenses may be underreported as spending on indirect lobbying via trade associations or other types of organizations are not reported at the firm-level. A benefit of the OPSW determinants of cash framework (Equation (1)) is that it specifies controls for firm size and Fama and French (1998) industry dummies. This is important as 1) larger firms likely pay a greater share of their respective industries’ trade association lobbying expenses and 2) industry trade association lobbying expenses vary by industry as the benefits from lobbying exhibit cross-industry variation. In a similar fashion, Equation (2) accounts for unobserved heterogeneity that may control for funds given to the industry trade association.
We should note that observations are also lost because of the method used to estimate an accurate and backward looking cash flow volatility measure.
For the estimation of Eq. (2), we begin with original, raw sample of merged Compustat and lobbying data. We then delete observations for missing financial statement data needed to estimate Eq. (2). Also, we winsorize the sample based on the levels of the financial characteristics specified in Eq. (2).
Likewise, using the natural logarithm of the cash-to-net assets ratio for multivariate models is consistent with OPSW.
The descriptive statistics for the lobbying variables are similar to those reported by Chen et al. (2009) and Hill et al. (2010).
The null hypothesis of the equality of variance is rejected at the one percent level, so the t test is calculated assuming unequal variances.
Unreported pairwise correlations among the control variables do not suggest collinearity problems.
Results for model estimated with Newey and West (1987) standard errors, which correct for heteroskedasticity and autocorrelation, yield quantitatively and qualitatively similar results.
Results are available upon request.
The residuals are again insignificant if we over-identify the first-stage regression and include the natural logarithm of sales. We thank an anonymous reviewer for suggesting that we examine simultaneity bias.
Although the model does not appear to exhibit signs of simultaneity bias, we note that all cross-sectional valuation models that rely on accounting information may suffer from endogeneity problems (Gil-Alana et al. (2011).
This restriction amounts to dropping inflation-adjusted annual lobby expenditures in excess of $9.61 M. Note that the data was initially winsorized at the one percent level for both tails of each variable included in Eq. (1). Thus, dropping the observations with the twenty largest lobby expenditures is after winsorizing the data.
A longer panel would help strengthen future inferences with respect to the impact of changes in political party power and the benefits from corporate lobbying. We thank an anonymous reviewer for suggesting this comment.
While the cash-lobbying coefficients are economically large, please note that the ratio of lobby expenditures to net assets is quite small, which provides for meaningful economic interpretations as discussed later.
The standard deviation of ΔLobby i,t is 0.0003879. Note that this value is less than that reported for Lobby_Ratio t-1 reported in Table 1, which is attributable to differences in sample sizes. Descriptive statistic results for each sample are available upon request.
Hill et al. (2010) show that corporate lobbying activity is related to size, growth opportunities, research and development expenditures, and industry affiliation. We do not consider research and development expenditures as an exclusion restriction since it already appears in the structural equation (Eq. 2). Although Hill et al. (2010) measure growth opportunities using the market-to-book ratio, we instrument for this variable using sales growth since a variant of the market-to-book ratio is our dependent variable in the second stage regression. Overall, our first stage regression consists of the variables in Eq. (2) (sans the prior and future changes in lobbying activity) along with lagged natural logarithm of sales, lagged growth in sales, and industry dummies.
We thank an anonymous reviewer for suggesting we estimate this model specification.
Note that the data was initially winsorized at the one percent level for both tails of each variable included in Eq. (2). Thus, dropping the observations with the twenty largest lobby expenditures is after winsorizing the data.
Acharya V, Almeida H, Campello M (2007) Is Cash Negative Debt? A Hedging Perspective on Corporate Financial Policies, Journal of Financial Intermediation 16:515–554
Bates T, Kahle K, and Stulz R (2009) Why Do U.S. firms hold so much more cash than they used to? J Finance, Forthcoming.
Boubakri, N., O. Guedhami, D. Mishra, and W. Saffar, 2009, Political Connections and the Cost of Equity Capital, Working Paper, University of South Carolina
Caprio L, Faccio M, and McConnell J (2008) Sheltering corporate assets from political extraction, Working paper, Purdue University
Charumilind C, Kali R, Wiwattanakantang Y (2006) Connected Lending: Thailand Before the Financial Crisis. J Bus 79:181–217
Chen H, Parsley D, Yang Y (2009) Corporate Lobbying and Financial Performance, Working Paper, Vanderbilt University
Chung D (1999) The Informational Effect of Corporate Lobbying Against Proposed Accounting Standards. Rev Quant Financ Acc 12:243–269
Claessens S, Feijen E, Laeven L (2008) Political Connections and Preferential Access to Finance: the Role of Campaign Contributions. J Financ Econ 88:554–580
Denis D and Sibilkov V (2009) Financial constraints, investment, and the value of cash holdings. Rev Financ Stud (forthcoming)
Dittmar A, Mahrt-Smith J (2007) Corporate Governance and the Value of Cash Holdings. J Financ Econ 83:599–634
Drobetz W, Gruninger MC, and Hirschvogl S (2010) Information asymmetry and the value of cash. J Banking Finance Forthcoming
Faccio M (2006) Politically Connected Firms. American Economic Review 96:369–385
Faccio M (2007) The characteristics of politically connected firms, Working Paper, University of Purdue
Faccio M, Masulis R and McConnell J Political connections and corporate Bailouts. Journal of Finance 61: 2597–2635
Faccio M and Parsley M (2008) Sudden deaths: taking stock of geographic ties. J Financ Quant Anal (forthcoming)
Faleye O (2004) Cash and Corporate Control. Journal of Finance 59:2041–2060
Fama E, French K (1998) Taxes. Financing Decisions, and Firm Value, Journal of Finance 53:819–843
Faulkender M, Wang R (2006) Corporate Financial Policy and the Value of Cash. Journalof Finance 61:1957–1990
Fisman R (2001) Estimating the Value of Political Connections. American Economic Review 91:1095–1102
Flannery M and Lockhart B (2010) Credit lines and the substituitability of cash and debt, Working paper, University of Nebraska
Foley C, Hartzell J, Titman J, Twite G (2007) Why do firms hold so much cash? A tax based explanation. J Financ Econ (forthcoming)
Fresard L and Silva C (2010) The value of excess cash and corporate governance: evidence from US cross-listings. J Financ Econ (forthcoming)
Garcia-Teruel P and Martinez-Solano P (2010) A dynamic perspective on the determinants of accounts payable. Rev Quantitative Finance Account (forthcoming)
Gil-Alana L, Iniguez-Sanchez R, Lopez-Espinosa G (2011) Endogenous Problems in Cross-Sectional Valuation Models Based on Accounting Information. Rev Quant Financ Acc 37:245–265
Goldman E, Rocholl J, So J (2008) Do Politically Connected Boards Affect Firm Value?. Review of Financial Studies, Forthcoming
Grossman G, Helpman E (1994) Protection for Sale. American Economic Review 84:833–850
Han S, Qiu J (2007) Corporate Precautionary Cash Holdings. Journal of Corporate Finance 13:43–57
Harford J, Mansi S, Maxwell W (2008) Corporate Governance and Firm Cash Holdings in the US. J Financ Econ 87:535–555
Hill, M., G.W. Kelly, B. Lockhart, and R. Van Ness, 2010, Determinants and Effects of Corporate Lobbying, Working Paper, University of Mississippi
Johnson S, Mitton T (2003) Cronyism and Capital Controls: evidence From Malaysia. J Financ Econ 67:351–382
Keynes JM (1936) The General Theory of Employment. Interest and Money, Cambridge
Kim C, Mauer D, Sherman A (1998) The Determinants of Corporate Liquidity: theory and Evidence. Journal of Financial Quantitative Analysis 33:305–334
Klasa, S., W. Maxwell, and H. Ortiz-Molina, 2008, The Strategic Use of Corporate Cash Holdings in Collective Bargaining with Labor Unions, Journal of Financial Economics, Forthcoming
Lee W (2011) Managerial Entrenchment and the Value of Dividends. Rev Quant Financ Acc 36:297–322
Myers S, Majluf N (1984) Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have. J Financ Econ 13:187–221
Newey W, West K (1987) A simple, positive semi-definite, heteroskedasticity and autocorrelation consistent matrix. Econometrica 55:703–708
Opler T, Pinkowitz L, Stulz R, Williamson R (1999) The Determinants and Implications of Corporate Cash Holdings. J Financ Econ 52:3–46
Ozkan A and Ozkan N (2004) An empirical analysis of the cash holdings of UK companies. J Bank Finance 28
Petersen M (2008) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud (forthcoming)
Pinkowitz L, Williamson R (2007) What is the Market Value of a Dollar of Corporate Cash? Journal of Applied Corporate Finance 19:81–87
Pinkowitz L, Stulz R, Williamson R (2006) Does the Contribution of Corporate Cash Holdings and Dividends to Firm Value Depend on Governance?, A Cross-country Analysis. Journal of Finance 61:2725–2752
Tong Z Firm diversification and the value of cash holdings. J Corp Finance (forthcoming)
Yu F and Yu X. Corporate lobbying and fraud protection, Working paper, University of Indiana
About this article
Cite this article
Hill, M.D., Fuller, K.P., Kelly, G.W. et al. Corporate cash holdings and political connections. Rev Quant Finan Acc 42, 123–142 (2014). https://doi.org/10.1007/s11156-012-0336-6
- Corporate lobbying
- Political connections