Insider Trading Has a New Face

Do Politically Connected Corporations Have Higher Returns? An Empirical Analysis of Congress 

Reviewed by Katherine Jin
June 14, 2014

Corporate insider trading is not the only type of illegal insider trading; political insider trading, where politicians exploit information and power dynamics to gain abnormal returns, can be just as pervasive. In “Do politically connected corporates have higher returns? An empirical analysis of the Congress”, Vamika Bajaj analyzed investment trends to determine the frequency of correlation between a firm’s political connectedness and returns on its equities for both members of the House of Representatives and the Senate.

While political insider trading cases vary from country to country, without a doubt, this issue is has been subject to controversy in France, Germany, and even the United States. But because of the Ethics in Government Act, passed in 1978, along with the Dodd-Frank Act, the United States has enjoyed greater transparency laws than its contemporaries. Therefore, beginning in 2004, periodic financial disclosures by members of both the House of Representatives and the Senate are accessible over the Internet. Using this available data, along with the S&P 500 equity indices, Bajaj investigated possible correlation between a firm’s political connectedness, returns on its equities, and member of the House of Representatives or the Senate.

Notably, total returns on firms with political investment are statistically significantly lower than those without. But because the standard deviation of returns is lower, this perhaps suggests that, while returns are lower, returns also have less associated risk. Furthermore, the average market value of firms with political connectedness, whether to the House of Representatives or the Senate, is significantly higher. The author inferred that this showed that politicians usually invest in companies with high market capitalization. Lastly, the data illustrated that political connection does have a positive effect on returns, but is interestingly higher for the Senate than the House of Representatives.

The higher positive effect on the Senate over the House of Representatives could be explained by several reasons. First, because the Senate is smaller, power and information are more concentrated. Secondly, the average senator is older and wealthier than the average representative. Because there is larger element of prestige associated with the Senate, perhaps this strengthens information and networking. Lastly, members of the Senate serve six-year terms, in comparison to members of the House of Representatives who serve two. This gives senators more ample time to develop relationships with firms and corporations. It is also important to emphasize that while there exists a positive correlation between political connectedness and returns, this does not necessarily indicate political insider trading. It is greatly possible that politicians benefit legitimately from trading due to personal networking, independent of power abuses in Congress.

See the full paper here!

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