With the SEC still sorta thinking about requiring U.S. public firms to disclose their political expenditures, a newly posted paper by Saumya Prabhat and David Primo (of the Indian School of Business in Hyderabad and University of Rochester, respectively) should be getting some play. Prabhat and Primo claim to find evidence that the U.K.’s enactment of similar disclosure rules in 2000 was bad for shareholders of politically active firms, and they argue this is a reason to oppose possible U.S. reforms. I think they’ve got at least one really big methodological problem, and even taking their results at face value they’re just misinterpreting them.
Let’s start with their findings. Prabhat & Primo report that news of the expected reforms increased stock-price volatility for politically-active firms (16) and that a portfolio of active firms performed worse after news broke than a portfolio of other firms (18). For some reason they emphasize the first much more, even though it’s kind of a no-brainer that there will be stock price volatility for regulated firms when the market gets information about a new regulation affecting them.
I’ll focus on the second finding. First, causation or correlation? As P&P themselves note, many firms lobby as a fallback when things go badly, or to close off entry by threatening new competitors. Others lobby to head off government investigations or regulatory actions. Is it surprising, then, that the firms that were lobbying just before the period P&P observe performed worse than other firms? Probably not: lobbying is itself a red flag that there’s a rocky road ahead. Or, at a minimum, it is a signal to the market that managers know there is a potential pothole looming.
Since this is a post about the value (or not) of disclosure, let me say that again. News about firm lobbying could provide information to the market about managers’ private knowledge of looming challenges for the firm. And nothing that P&P report is inconsistent with that story.
Here’s another way in which their results show that disclosure was good for shareholders. Let’s say that most lobbying by individual firms is firm-specific rent-seeking. (Firms may also sometimes be willing lobby for collective goods, but often that is done through trade associations). From a diversified shareholder perspective, all firm-specific rent-seeking is destructive. The lobbying is moving money from Firm A to Firm B. I’m invested in both. So the two firms are wasting resources to fight over which of my pockets my money is in. (Contrast this with money spent on, say, R&D, which does just shift pockets to some extent but also contributes to growth). And maybe I’m also a consumer. They’re trying to shut out new competitors, keeping the prices I pay high.
Disclosures allow me, the diversified investor, to identify which firms are wasting my investment in this way. You can understand why undiversified managers would prefer to enrich themselves at the expense of competitors, but this is exactly the kind of self-serving behavior that investors want to curtail. So, long story short, if disclosure is actually reducing firm value, that could simply represent the fact that shareholders are unwilling to invest in managerial self-dealing.