Firms often work with politicians and former regulators to navigate the corporate
world—in particular, mergers and acquisitions. The authors aim to explore and
establish the nexus between political connectedness and heightened merger activity. The
critical issues are whether the political connectedness of firms (i.e., having former
politicians and regulators on boards of directors or management teams) influences the
frequency, deal size, and success rate of mergers that undergo regulatory scrutiny and
whether acquirers exhibit better operating performance after the merger.
How Is This Research Useful to Practitioners?
Most analysts (whether equity or fixed income) have a hard time predicting the growth of
companies, especially when that growth is led by a merger or an acquisition. Analysts and
portfolio managers need clarity on the size of the merger, the likely premium paid, the
regulatory outcome of antitrust and other laws, and most importantly, whether the
post-merger performance justifies the capital allocation. For portfolio managers and
fixed-income investors, acquisition events often trigger a debt repayment, a default, or a
need to rebalance the portfolio because of credit-rating changes. The authors’
results can help analysts understand that politically connected bidders are more likely to
acquire targets than are bidders that are not politically connected.
The targets of connected firms are also larger than those of nonconnected acquirers and are
likely to have superior post-merger financial and accounting performance. The authors
provide evidence that connected acquirers receive higher five-year abnormal returns as well
as industry-adjusted returns on assets than do nonconnected acquirers. This performance
could be attributed to the firms’ ability to use private information about the
regulatory landscape and/or the lobbying access that politicians and former regulators can
offer them. Practitioners should be wary of potential merger activity when there are
board-level changes involving connected people.
How Did the Authors Conduct This Research?
The authors use the CRSP and Compustat databases for US public companies (both target and
acquirer) over 1997–2013 for deals of more than $1 million. Using a filter for their
sample, they require that the acquirer own less than 50% of the outstanding shares of the
target six months before the bid announcement and seek to acquire more than 90% after the
deal. The relative value of the deal is at least 1% of the bidder’s size. The authors
obtain regulatory data from both the Federal Trade Commission and the Antitrust Division of
the Department of Justice.
Three indicator variables are used to measure the bidder’s political
connectedness—that is, whether the bidder has on its board or management team or as an
employee such types of individuals as a former politician, an industry regulator, a general
or admiral, or a noncounsel lawyer. Using descriptive and comparative sample statistics to
examine their data, the authors showcase their results on the amount of merger activity by
both connected and nonconnected firms. This phenomenon is more evident in industry sectors
where the regulations are more complex—for example, telecommunications, heavily
regulated utilities, and financial services. They then estimate the success of mergers and
political connectedness on the basis of probit models using regression and correlation. In
estimating takeover premiums, the authors use three measures: PREMMOEL (Harford,
Journal of Financial Economics 2005), PREMISM (Ismail, Financial
Management 2011), and PREMBET (Betton, Review of Financial
Studies 2000). To address endogeneity and the omitted-variables effect, they use
an instrumental-variable approach and a difference-in-differences framework.
Most businesses engage in some form of advocacy or lobbying with regulators. This
engagement can be in the form of political donations or the appointment of a former
regulator or politician to the management team or board in the hope that the firm will sail
through any regulatory scrutiny. Firms may use either option to enhance their reputation,
gain attention from investors, or obtain guidance in setting up new businesses or in
navigating the licensing process.
Although the authors conclusively demonstrate the relationship between (1) political
connectedness and (2) merger success and operating performance, they are unclear about the
exact quantitative factors that lead to these results. Some industry sectors—including
telecommunications, financial services, and utilities—often have monopolistic or
oligopolistic characteristics and thus have stronger, more stable cash flows that are bound
to strengthen operating performance regardless of political connectedness. The authors fail
to identify clearly how political connectedness helps the acquirer generate higher
post-merger returns. Because the authors’ dataset is limited to the United States,
their results may be less applicable to the fragmented economies in Europe and Asia.