The economics of corporate lobbying

In my ECONS102 class, we talk about market power and monopoly firms, and in the context of that discussion, we talk about corporate lobbying. Specifically, we discuss it in the context of rent-seeking behaviour (as I have previously blogged about here). The assumption of firms conducting lobbying for rent-seeking reasons is that they do so in order to protect (or enhance) their profits in the future. So, firms that engage in rent-seeking should be expected to be more profitable (net of their rent-seeking expenditure) than those that don't engage.

A recent paper by Zhiyan Cao (University of Washington Tacoma), Guy Fernando (SUNY Albany), Arindam Tripathy (UW Tacoma), and Arun Upadhyay (Florida International University), published in the Journal of Corporate Finance (sorry I don't see an ungated version anywhere online) challenges this result. The authors contrast between two different theories of how corporate political activity (including lobbying, but also contributions to political campaigns, etc.) would affect profitability:

The stewardship theory views lobbying as an inherent part of firm strategy. The rationale is that since government regulations and actions can shape a firm's business conditions, lobbying could be an effective means to help firms stay informed of regulatory agenda, obtain political information to adjust their business decisions in a timely fashion, and to encourage (discourage) those regulatory decisions that are beneficial (detrimental) to a firm when possible. Under this theory, lobbying expenditure is considered an outlay with a high return on investment (ROI)...

...a new paradigm that attempts to explain corporate lobbying focuses on the agency problems... Specifically, managers may divert corporate resources directly to strengthen their own political connections through lobbying activities without bringing tangible benefits to the firm.

So, the stewardship theory suggests a positive relationship between lobbying and profits, but agency theory suggests a neutral or even negative relationship between lobbying and profits, because managers are doing what is in their own personal best interests and not necessarily those of the firm. Cao et al. suggest some specific examples of principal-agent problems associated with lobbying, including:

First, lobbying may channel funds for political causes that are dear to the CEO, but do not affect (or adversely affect) the firm...

...Second, lobbyists (who are agents of their clients, the firms) may misrepresent the lobbying activities to their clients and direct corporate funds to causes dear to the lobbyists... Third, the firm (and presumably the majority shareholders) may channel firm money to political activities that are inimical to the beliefs and philosophies of the non-controlling shareholders... Finally, corporate political activity can be chosen by incompetent CEOs who are unable to lead their firms to meet new challenges in the marketplace and overestimate the effectiveness of lobbying as a means to enroll government welfare in the face of competition. Managers may also be more likely to shirk when they expect to resort to political connections through lobbying.

Using data on 18,075 firm-years from 2186 unique firms over the period from 1998 to 2016, they find support for agency theory as a dominant factor:

...we find a negative and significant association between lobbying activities and firm performance. This negative association persists when we explicitly control for the endogeneity of corporate lobbying. We further show that the negative association may be partly explained by the fact that lobbying spending by a firm overall provides limited tangible benefits when it comes to helping the firm obtain more government contracts or improve the frequency of getting a bill passed in the US Congress. This suggests that agency costs (e.g., inefficient use of corporate funds) in lobbying activities appear to dominate the strategic benefits that firms may obtain from lobbying.

This is a nice paper, and includes a very thorough set of robustness checks and checks using alternative econometric specifications. So, the results are very believable. However, two things suggest to me that this is far from the last word on the relationship between corporate lobbying and profits. First, the quality of lobbying expenditure clearly matters as much as (if not more than) the quantity of corporate lobbying. This is a very difficult problem to address in an econometric model, since high-quality corporate lobbying could be most simply defined as lobbying that results in a favourable outcome. However, definitional issues aside it is likely that firms that engage in higher quality lobbying are more likely to improve their profits as a result. So, failing to account for the quality of lobbying is a potentially important issue for this research.

Second, there is a public goods aspect to at least some lobbying expenditure, which is not accounted for in the paper. If Firm A lobbies against a particular law that would impose restrictions on their industry (or on business more generally), the all firms in the same industry (or in all industries, depending on the extent of coverage of the law) would benefit. If the lobbying was successful, Firm A would receive a benefit (higher profits), but face the cost of lobbying. Other firms in the same industry (or generally) would receive higher profits, but face no corresponding lobbying cost. To an econometric model, this would look like a negative relationship between lobbying expenditure and profits. So, for this reason I don't think we can take the negative relationship between lobbying and profits from this paper as being purely an agency problems result.

Corporate lobbying is an important feature of modern politics. The paper has some interesting figures on the extent of lobbying which illustrate this, including the peak lobbying expenditure of Pfizer, which by itself spent over US$63 million on lobbying in 2009. Clearly, this is an issue that needs to be kept in the spotlight.

[HT: Marginal Revolution, back in January]