Skip to main content

Advertisement

SpringerLink
Log in

Political Corruption and Corporate Risk-Taking

  • Original Paper
  • Published:
Journal of Business Ethics Aims and scope Submit manuscript

Abstract

We use variation in corruption convictions across judicial districts in the US to examine the relationship between political corruption and risk-taking of public firms. Firms headquartered in regions with high levels of political corruption have lower total risk and lower idiosyncratic risk on average. Further analysis shows that corruption tends to encourage firms to pursue risk-decreasing investments, lower the riskiness of their operations, and decrease asset liquidity. While managerial ownership is intended to align the interests of managers and shareholders, the presence of corruption appears to encourage undiversified managers to decrease risk-taking. Our evidence is consistent with agency theory and the asset-shielding argument that political corruption discourages managers from taking risks that expose firms to expropriation by politicians, resulting in suboptimal corporate policies.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. These industries are highly regulated and generally excluded in corporate finance studies. It is possible, however, that intense regulation creates even more opportunities for corruption. The results presented here are robust to the inclusion of these two industries (see Table A1 in the Online Appendix).

  2. CEO delta measures the change in the CEO’s wealth given a 1% change in stock prices. CEO vega measures the change in the CEO’s wealth given a 0.01 change in stock return volatility. Both are estimated using the Black–Scholes option-pricing model and all holdings reported in Execucomp. Both variables are measured in dollars, so we use the natural logarithm in our analysis.

  3. In unreported analysis, we use the risk measures calculated from the actual stock returns of both single- and multi-segment firms and find our results qualitatively unchanged.

  4. We begin with a sample of 42,682 firm-year observations in the Compustat database during the sample period. The number of firm-year observations decreases to 36,329 after we drop firms from the utility and financial industries. After merging the sample with CEO compensation data from the Execucomp database and excluding firm-year observations with missing CEO delta and CEO vega, we obtain the final sample of 17,682 firm-year observations of 2107 multi-segment firms.

  5. In unreported analysis, we control for firm fixed effects instead of industry fixed effects in the regressions, but the results remain qualitatively unchanged. Our results are qualitatively similar if we cluster standard errors by judicial districts.

  6. We thank Campante and Do for making the isolation of capital city data available.

  7. In an unreported analysis, we use the state-level shocks to newspaper reporter employment as an additional instrument for political corruption (Brown et al., 2019), but our results remain qualitatively unchanged.

  8. We control for both GDP growth rate and GDP per capita because Barro and Lee (1993) argue that GDP can grow faster with a lower GDP per capita given an initial level of human capital.

  9. Local corruption is likely to be more extensive if a firm primarily operates in one area, but less so if it operates across multiple states. Using data from Garcia and Norli (2012) to measure firm concentration, we find that concentrated firms are more affected by local corruption. We report these results in Table A2 in the Online Appendix.

  10. As the HHI data are available from 1996, our corporate investment subsample consists of 14,631 firm-year observations.

  11. Hossain and Kryzanowski (2020) define acquisitions as a method for shielding assets from rent-seeking behavior. We focus only on firms that acquired other firms, though the acquisition itself may have occurred as a result of operating in high corruption areas.

  12. In an unreported analysis, we find that corruption reduces capital expenditures and R&D, which is consistent with the evidence reported in the literature (Ellis et al., 2020; Huang and Yuan 2021). Moreover, the relationship is stronger for R&D, implying a more pronounced effect of corruption on idiosyncratic risk because R&D tends to increase firm idiosyncratic risk more (Bhagat and Welch 1995; Bhattacharya et al., 2017; Kothari 2001). However, CEO ownership may also affect a firm’s investment level in R&D independent of corruption (e.g., Abdoh and Liu 2020).

  13. In an unreported analysis, we also find that corruption leads to under-investment by a firm, which is a manifestation of suboptimal investment. These results are available on request.

References

  • Abdoh, H., & Liu, Y. (2020). Executive risk incentives, product market competition, and R&D. Financial Review, 56(1), 133–156.

    Article  Google Scholar 

  • Ades, A., & Di Tella, R. (1999). Rents, competition, and corruption. American Economic Review, 89(4), 982–993.

    Article  Google Scholar 

  • Armstrong, C. S., & Vashishtha, R. (2012). Executive stock options, differential risk-taking incentives, and firm value. Journal of Financial Economics, 104, 70–88.

    Article  Google Scholar 

  • Ayyagari, M., Demirgüç-Kunt, A., & Maksimovic, V. (2014). Bribe payments and innovation in developing countries: Are innovating firms disproportionately affected? Journal of Financial and Quantitative Analysis, 49, 51–75.

    Article  Google Scholar 

  • Barro, R. J., & Lee, J. W. (1993). Losers and winners in economic growth. The World Bank Economic Review, 7, 267–298.

    Article  Google Scholar 

  • Bhagat, S., & Welch, I. (1995). Corporate research and development investments international comparisons. Journal of Accounting and Economics, 19, 443–470.

    Article  Google Scholar 

  • Bhattacharya, U., Hsu, P.-H., & Tian, X., & Xu, Y. (2017). What affects innovation more: Policy or policy uncertainty? Journal of Financial and Quantitative Analysis, 52(5), 1869–1901.

    Article  Google Scholar 

  • Boylan, R., & Long, C. X. (2003). Measuring public corruption in the American states: A survey of state house reporters. State Politics and Policy Quarterly, 3, 420–438.

    Article  Google Scholar 

  • Brown, N., Smith, J., White, R., & Zutter, C. (2019). Political corruption and firm value in the US: Do rents and monitoring matter? Journal of Business Ethics, 168, 1–17.

    Google Scholar 

  • Butler, A., Fauver, L., & Mortal, S. (2009). Corruption, political connection, and municipal finance. Review of Financial Studies, 22, 2873–2905.

    Article  Google Scholar 

  • Campante, F., & Do, Q. (2014). Isolated capital cities, accountability, and corruption: Evidence from US states. American Economic Review, 104, 2456–2481.

    Article  Google Scholar 

  • Caprio, L., Faccio, M., & McConnell, J. (2013). Sheltering corporate assets from political extraction. Journal of Law, Economics, and Organization, 29(2), 332–354.

    Article  Google Scholar 

  • Chen, H., Kacperczyk, M., & Ortiz-Molina, H. (2011). Labor unions, operating flexibility, and the cost of equity. Journal of Financial and Quantitative Analysis, 46, 25–58.

    Article  Google Scholar 

  • Coles, J., Daniel, N., & Naveen, L. (2006). Managerial incentives and risk-taking. Journal of Financial Economics, 79(2), 431–468.

    Article  Google Scholar 

  • Collins, J., Uhlenbruck, K., & Rodriguez, P. (2009). Why firms engage in corruption: A top management perspective. Journal of Business Ethics, 87, 89–108.

    Article  Google Scholar 

  • De Soto, H. (1989). The other path: The invisible revolution in the third worlds. Harper and Row Publishers.

  • Dincer, O. (2019). Does corruption slow down innovation? Evidence from a co-integrated panel of U.S. states. European Journal of Political Economy, 56, 1–10.

    Article  Google Scholar 

  • Ellis, J., Smith, J., & White, R. (2020). Corruption and corporate innovation. Journal of Financial and Quantitative Analysis, 55, 2124–2149.

    Article  Google Scholar 

  • Emerson, P. (2006). Corruption, competition and democracy. Journal of Developmental Economics, 81(1), 193–212.

    Article  Google Scholar 

  • Faccio, M., & Hsu, H. (2017). Politically connected private equity and employment. Journal of Finance, 72, 539–574.

    Article  Google Scholar 

  • Faccio, M., Marchica, M., & Mura, R. (2016). CEO gender, corporate risk-taking, and the efficiency of capital allocation. Journal of Corporate Finance, 39, 193–209.

    Article  Google Scholar 

  • Faccio, M., Masulis, R., & McConnell, J. (2006). Political connections and corporate bailouts. Journal of Finance, 61, 2597–2635.

    Article  Google Scholar 

  • Fama, E., & French, K. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3–56.

    Article  Google Scholar 

  • Ferris, S. P., Javakhadze, D., & Rajkovic, T. (2017). CEO social capital, risk-taking and corporate policies. Journal of Corporate Finance, 47, 46–71.

    Article  Google Scholar 

  • Florackis, C., Kanas, A., Kostakis, A., & Sainani, S. (2020). Idiosyncratic risk, risk-taking incentives and the relation between managerial ownership and firm value. European Journal of Operational Research, 283, 748–766.

    Article  Google Scholar 

  • Friend, I., & Lang, L. (1988). An empirical test of the impact of managerial self-interest on corporate capital structure. Journal of Finance, 43(2), 271–281.

    Article  Google Scholar 

  • Fulmer, S., Knill, A., & Yu, X. (2012). Political contributions and the severity of government enforcement. Unpublished manuscript. Florida State University.

  • Garcia, D., & Norli, Ø. (2012). Geographic dispersion and stock returns. Journal of Financial Economics, 106, 547–565.

    Article  Google Scholar 

  • Ghosal, V., & Loungani, P. (1996). Product market competition and the impact of price uncertainty on investment: Some evidence from U.S. manufacturing industries. Journal of Industrial Economics, 44(2), 217–228.

    Article  Google Scholar 

  • Goldman, E., Rocholl, J., & So, J. (2013). Politically connected boards of directors and the allocation of procurement contracts. Review of Finance, 17, 1617–1648.

    Article  Google Scholar 

  • Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118, 107–156.

    Article  Google Scholar 

  • Gormley, T., & Matsa, D. (2016). Playing it safe? Managerial preferences, risk, and agency conflicts. Journal of Financial Economics, 122, 431–455.

    Article  Google Scholar 

  • Guay, W. (1999). The sensitivity of CEO wealth to equity risk: An analysis of the magnitude and determinants. Journal of Financial Economics, 53, 43–71.

    Article  Google Scholar 

  • Habiyaremye, A., & Raymond, W. (2013). Transitional corruption and innovation in transition. UNU-MERIT Working Paper Series #2013-050. United Nations University.

  • Hartzell, J. C., & Starks, L. T. (2003). Institutional investors and executive compensation. Journal of Finance, 58(6), 2351–2374.

    Article  Google Scholar 

  • Hoberg, G., & Phillips, G. (2016). Text-based network industries and endogenous product differentiation. Journal of Political Economy, 124(5), 1423–1465.

    Article  Google Scholar 

  • Holmstrom, B. (1979). Moral hazard and observability. Bell Journal of Economics, 10(1), 74–91.

    Article  Google Scholar 

  • Hossain, A., & Kryzanowski, L. (2020). Political corruption shielding and corporate acquisitions. Financial Review, 56(1), 55–83.

    Article  Google Scholar 

  • Huang, Q., & Yuan, T. (2021). Does political corruption impede firm innovation? Evidence from the United States. Journal of Financial and Quantitative Analysis, 56(1), 1–36.

    Article  Google Scholar 

  • Huntington, S. (1968). Political order in changing societies. Yale University Press.

    Google Scholar 

  • John, K., Litov, L., & Yeung, B. (2008). Corporate governance and risk-taking. Journal of Finance, 63, 1679–1728.

    Article  Google Scholar 

  • Kato, A., & Sato, T. (2015). The effects of corruption on the manufacturing sector in India. Economics of Governance, 15(2), 155–178.

    Article  Google Scholar 

  • Kim, C., Pantzalis, C., & Park, J. (2013). Do family owners use firm hedging policy to hedge personal undiversified wealth risk? Financial Management, 43(2), 415–444.

    Article  Google Scholar 

  • Kim, E. H., & Lu, Y. (2011). CEO ownership, external governance, and corporate risk-taking. Journal of Financial Economics, 102(2), 272–292.

    Article  Google Scholar 

  • Kothari, S. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31(1–3), 105–231.

    Article  Google Scholar 

  • Kroszner, R., & Stratmann, T. (1998). Interest-group competition and the organization of congress: Theory and evidence from financial services’ political action committees. American Economic Review, 88(5), 1163–1187.

    Google Scholar 

  • Leff, N. (1964). Economic development through bureaucratic corruption. American Behavioral Science, 8(2), 8–14.

    Article  Google Scholar 

  • Leland, H. (1998). Agency costs, risk management, and capital structure. Journal of Finance, 53(4), 1213–1243.

    Article  Google Scholar 

  • Lewellen, K. (2006). Financing decisions when managers are risk averse. Journal of Financial Economics, 82, 551–589.

    Article  Google Scholar 

  • Li, K., Griffin, D., Yue, H., & Zhao, L. (2013). How does culture influence corporate risk-taking? Journal of Corporate Finance, 23, 1–22.

    Article  Google Scholar 

  • Mandelker, G., & Rhee, S. (1984). The impact of the degrees of operating and financial leverage on systematic risk of common stock. Journal of Financial and Quantitative Analysis, 19(1), 45–57.

    Article  Google Scholar 

  • Mauro, P. (1995). Corruption and growth. Quarterly Journal of Economics, 110, 681–713.

    Article  Google Scholar 

  • Murphy, K., Shleifer, A., & Vishny, R. (1993). Why is rent-seeking so costly to growth? American Economic Review, 83, 409–414.

    Google Scholar 

  • Nguyen, N., Doan, Q., Nguyen, N., & Tran-Nam, B. (2016). The impact of petty corruption on firm innovation in Vietnam. Crime, Law, and Social Change, 65(4–5), 337–394.

    Google Scholar 

  • Nguyen, N., Phan, H., & Simpson, T. (2020). Political corruption and mergers and acquisitions. Journal of Corporate Finance, 65, 101765.

    Article  Google Scholar 

  • Ovtchinnikov, A., Reza, S., & Wu, Y. (2020). Political activism and firm innovation. Journal of Financial and Quantitative Analysis, 55(3), 989–1024.

    Article  Google Scholar 

  • Panousi, V., & Papanikolaou, D. (2012). Investment, idiosyncratic risk, and ownership. Journal of Finance, 67, 1113–1148.

    Article  Google Scholar 

  • Shleifer, A., & Vishny, R. (1993). Corruption. Quarterly Journal of Economics, 108, 599–617.

    Article  Google Scholar 

  • Smith, J. (2016). U.S. political corruption and firm financial policies. Journal of Financial Economics, 121, 350–367.

    Article  Google Scholar 

  • Stigler, G. (1971). The theory of economic regulation. The Bell Journal of Economics and Management Science, 2(1), 3–21.

    Article  Google Scholar 

Download references

Acknowledgements

We thank Greg Shailer (the Section Editor) and two anonymous reviewers for helpful comments. Khieu would like to thank participants at the Prairie View A&M University College of Business research seminar for their insightful comments. All errors remain the sole responsibility of the authors.

Author information

Authors and Affiliations

  1. Prairie View A&M University, Prairie View, TX, 77446, USA

    Hinh Khieu

  2. Robert C. Vackar College of Business & Entrepreneurship, University of Texas Rio Grande Valley, 1201 W University Dr, Edinburg, TX, 78539, USA

    Nam H. Nguyen

  3. Manning School of Business, University of Massachusetts Lowell, 72 University Avenue, Lowell, MA, 01854, USA

    Hieu V. Phan

  4. Department of Economics and Finance, School of Business Administration, University of Dayton, 300 College Park, Dayton, OH, 45469, USA

    Jon A. Fulkerson

Authors
  1. Hinh Khieu
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Nam H. Nguyen
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Hieu V. Phan
    View author publications

    You can also search for this author in PubMed Google Scholar

  4. Jon A. Fulkerson
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Hieu V. Phan.

Ethics declarations

Conflict of interest

The authors declare that they have no conflict of interest.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Supplementary Information

Below is the link to the electronic supplementary material.

Supplementary file1 (DOCX 23 kb)

Appendix

Appendix

Variables definition

Variable names

Construction

Data source

Book leverage

The ratio of book value of short-term and long-term debts to book value of assets

Compustat

Book-to-market ratio

The ratio of book value to market value of total assets

Compustat

Political corruption

The yearly number of convictions per 100,000 residents of the judicial district in which the firm is headquartered

Hand collected

Plant, property, and equipment (PP&E)

The net plant, property, and equipment scaled by total assets

Compustat

Sales growth

The growth in annual sales over the prior year

Compustat

Annual sales

The natural logarithm of the firm’s annual sales

Compustat

Total risk

The standard deviation of 3-year rolling monthly imputed returns

CRSP

Systematic risk

The square root of the explained variance of the regression of the imputed monthly returns on Fama–French (1993) three factors

CRSP

Idiosyncratic risk

The square root of the unexplained variance of the regression of the imputed monthly returns on Fama–French three-factor model

CRSP

CEO ownership

The ratio of CEO stock ownership to total common shares outstanding

Execucomp

CEO delta

The dollar change in the CEO’s wealth for a 1% change in stock price

Execucomp

CEO vega

The dollar change in the CEO’s wealth for a 0.01 change in standard deviation of stock returns

Execucomp

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Khieu, H., Nguyen, N.H., Phan, H.V. et al. Political Corruption and Corporate Risk-Taking. J Bus Ethics 184, 93–113 (2023). https://doi.org/10.1007/s10551-022-05136-8

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10551-022-05136-8

Keywords

JEL Classification

Search

Navigation