Economic Benefits of Firms' Government Sale Dependency

Abstract

In this paper, using a new channel of political connections, firm dependency on government sales, I study the value of political connections for firms. I find an economically and statistically significant relation between firm dependency on government entities in terms of revenues and the cross-section of future stock returns. Firms experience significantly higher profit margins post government dependency. In addition, past government sales significantly predict future government sales. The atypical features of government contracts and the information asymmetry between the contractor and contractee are likely to be behind the firms' higher profit margins. Further tests based on attention and uncertainty proxies suggest that investors' limited attention and greater valuation uncertainty contribute to abnormal returns. Furthermore, I find evidence suggesting that firms gain the wealth effects of political connections found by Cooper, Gulen, and Ovtchinnikov (2010) by winning material government contracts; however, the wealth effects of government dependency stay strong even after controlling for such connections.

Keywords: Government-Dependent Firms, Government Spending, Political Connections, Stock Returns

JEL Classification: G18, G38, H50, H57, H72