Political Connections to US State Attorneys and Resource Misallocation

• In Event: Firms and their political connections

Abstract

In the wake of the current opioid crisis in the US, the role of state attorney generals (state AGs henceforth) has received increased public attention: e.g., as a result of an investigation pushed by the Oklahoma state AG, Mike Hunter, Johnson & Johnson was ordered to pay $572 million in August 2019. This suggests that state AGs' actions can have potentially costly consequences for firms. In order to ameliorate such costs, one could hence expect that companies attempt to preempt or alleviate such costly consequences by establishing political connections to state AGs; in fact, there is some anecdotal evidence for that.
In my paper, I study the firm-level effects of political connections to state AGs quantitatively. I utilize the fact that one can observe the campaign contributions of firms to candidates for the state attorney general office in the 43 states that elect their state AGs; arguably, such campaign contributions may serve to establish a connection to the state AG. While influence peddling may be undesirable from a democratic standpoint, the economic efficiency implications may be more subtle. Connecting to the resource misallocation literature in economics, I argue that political connections may be inefficient as they lead to capital misallocation across firms. I furthermore examine the extent to which government accountability may moderate the welfare-suboptimal consequences of political connections, and propose that prosecution probabilities of antitrust violations and environmental regulation violations might be potential causal mechanisms.
The paper makes four contributions: first, the studied setting allows me to gauge the causal effects of political connections on resource misallocation; secondly, the mechanism at play is directly testable. Thirdly, I show that campaign contributions actually may have direct and tangible effects, as opposed to being a mere consumption expenditure as argued in the literature (see Ansolabehere et al. 2003). Lastly, I connect the economics literature on resource misallocation with the political economy literature on government accountability.
I show theoretically that firm productivity and firm capital are sufficient statistics for resource misallocation. If political connections lead to an increase in firm capital that is not paralleled by an increase in firm productivity, a resource – capital – is being misallocated.
In the empirical part, I leverage campaign contribution data in races to state AGs in the US (provided by followthemoney.org), and firm level financial data (Compustat). In order to causally identify the effect, I employ a regression discontinuity design. Moreover, I use randomization inference as an additional robustness check. I show that political connections causally lead to increases in firm capital of around 5 to 10 percent, while productivity remains constant; hence, political connections to state AGs lead to resource misallocation across firms. There is some indication that tighter accountability structures on state AGs leads to a reduction of this effect. I am currently in the process of gathering data on antitrust proceedings and environmental proceedings initiated by state AGs in order to gauge the causal mechanisms.

Author

• Johannes Wiedemann, Yale University