Companies Take Risks When Making Secret Political Contributions
‘Covert’ sponsorship of an embattled nonprofit — identified by a whistleblower — drove investors to sell off companies’ stock.
Based on the research of Timothy Werner
Companies often secretly contribute to political nonprofits to influence public policy. But depending on the organization they contribute to, it’s a risky practice.
If discovered, this so-called covert corporate political activity can threaten a company’s reputation and even drag down its share price. When investors find out that companies they’ve invested in have given money to controversial organizations, they react negatively, punishing the “irresponsible” business by driving down its stock price.
“Companies should really be thinking about the reputational risk they’re running and whether or not they need to engage in this sort of political activity at all,” says Timothy Werner, associate professor of business, government, and society at Texas McCombs. “There are other means of exerting influence that are perceived as more legitimate and more transparent.”
Werner is one of the lead authors of a new paper that looks at how investors respond to disclosures of covert contributions by businesses to political nonprofits.
To show how this covert corporate political activity affects companies, Werner and colleagues Ishva Minefee of Iowa State University and Mary-Hunter McDonnell of the University of Pennsylvania examined a whistleblower’s 2011 leak revealing corporate sponsors of the American Legislative Exchange Council (ALEC), a conservative 501(c)3 nonprofit “dedicated to the principles of limited government, free markets, and federalism.”
Negative Returns
Werner and his colleagues pulled data from an “ALEC Exposed” website launched by liberal watchdog group the Center for Media and Democracy, which was aided by a whistleblower inside of ALEC.
ALEC describes itself as nonpartisan, yet the majority of its membership of 2,000 state legislators identify as Republican. Its primary political task is to draft model bills that state legislators can tailor and introduce in local legislative bodies. At the time of the disclosure, the organization had come under fire for allegations it was abusing its charitable status, plus its controversial positions on voter registration laws and “stand your ground” gun laws.
The researchers looked at the share prices of 169 of the publicly traded companies identified on the ALEC Exposed website. They found that more than 59% of ALEC sponsors experienced negative returns — ranging from losses on average of 0.06% to 2.66% over various time frames — after the disclosure.
“Investors were worried about ALEC’s negative reputation spilling over onto the firm.” — Tim Werner
Werner and colleagues also found that for companies that had also faced a shareholder resolution on political disclosure in the past, this negative effect was greater, on average, than for those ALEC-giving companies that didn’t previously face such a resolution. “It’s really bad to get caught doing this when your shareholders asked you not to,” says Werner.
Investors also reacted more negatively when giving to ALEC was out of step with the ideology of most of a company’s employees. This was the case for companies including Amazon, General Mills, Consolidated Edison, and Amgen.
That’s probably because investors believed the mismatch could create unrest among employees, hurting retention and even recruitment. However, companies that previously built a good reputation with their corporate social responsibility initiatives got off easier — investors weren’t as hard on them.
“They built up a reservoir of good will,” Werner says, “and investors likely believed the contribution was for a rational, strategic reason rather than being something nefarious.”
Protecting Against Reputational Risk
The study builds off — and stands in contrast to — Werner’s earlier research that showed investors responded positively to covert contributions disclosed by The New York Times in 2014. The Times reported on 66 corporate contributors to a 501(c)4 social welfare organization linked to the Republican Governors Association (RGA), the Republican Governors’ Public Policy Committee.
In that case, investors saw the connection as a sign that the companies have access to governors and high-level staffers, Werner says. What’s more, the RGA — unlike ALEC — also was not mired in controversy at the time.
“Investors saw contributing to the RGA as a legitimate investment,” he says, “while giving to ALEC was seen as a source of reputational risk.”
The current research makes it clear that investors should be aware of the political risks companies might be taking, push them to voluntarily disclose contributions, or rally for legislation to do so, Werner says. For companies, the takeaway is to be careful when making contributions.
“Don’t assume that just because something is covert, it’s never going to see the light of day.” — Tim Werner
Companies may also want to consider alternative methods to influence public policy, such as lobbying on their own or through trade associations, which are seen as more above board.
Paying closer attention to whom you’re aligned with these days is critical, he adds, in a world where Americans are more polarized than ever based on their political party.
“The biggest threat in the current environment is that a firm could be seen as a Republican firm or a Democratic firm,” he says, “with people only patronizing certain companies based on their perceived political affiliation.”
“Reexamining Investor Reaction to Covert Corporate Political Activity: A Replication and Extension of Werner (2017),” is forthcoming, online in advance in the Strategic Management Journal.
Story by Deborah Lynn Blumberg
