Friends in Low Places: The Impact of Political Scandals on Connected Firms’ Stock Prices

Abstract

We use the exogenous nature of political scandals to test whether political connections in the form of campaign contributions expose firms to reputational risk. We hand-collect a sample of 218 scandals of members of the U.S. Congress that occurred between 2000 and 2019 and estimate the abnormal returns around the day a scandal first appeared in the news. We find that connected firms and to a lesser extent other politically active firms experience value losses around corruption scandals involving firms or lobbyists. These losses increase in managers’ propensity to engage in unethical behavior. Moreover, we find that following such corruption scandals shareholders of connected firms are more likely to submit proposals on the disclosure of political contributions, and connected firms reduce political spending. Overall, our results suggest that losses around scandals are driven by reputation spillover and investors updating their beliefs about the risks of political contributions.

Keywords: Corruption, political contributions, political scandals, reputation spillover, shareholder activism

JEL Classification: G14, G30, L14