A new study finds that a company is nearly four times more likely to receive an economic incentive in a state where the company makes political contributions to state-level candidates. The results also show that awarding economic incentives to politically-connected firms is not the most effective use of taxpayer funds.

In 1982, George Stigler was awarded the Alfred Nobel Memorial Prize in Economic Science for his seminal work on industrial structures, functioning of markets, and causes and effects of public regulation. In regard to the latter, one of Stigler’s most influential pieces notes that “the state—the machinery and power of the state—is a potential resource or threat to every industry in the society. With its power to prohibit or compel, to take or give money, the state can and does selectively help or hurt a vast number of industries.”

Our research considers the power of the state in shaping its citizens’ economic landscape by studying the US state governments’ use of corporate economic incentives, and how corporate political connections influence the likelihood, magnitude, and outcomes associated with incentive awards. Our analyses indicate that US state economic incentives are disproportionately awarded to politically-connected companies, even though these awards appear to be a less effective use of taxpayer-provided funds. Thus, nearly 50 years after Stigler’s pivotal article was published, we find that his words continue to ring true.

On September 7, 2017, corporate economic incentives roared back into the limelight when Amazon announced its search for a second headquarters location. The potential for a single location to receive an expected $5 billion of corporate investment and 50,000 new jobs created a bidding frenzy amongst state and local governments. More than 200 states, cities, and counties in North America submitted proposals to Amazon in hopes of being the chosen one. Some proposals seemed to be publicity stunts in disguise—officials from Tucson, Arizona sent a 21-foot saguaro cactus to Amazon’s Seattle headquarters, and officials from Stonecrest, Georgia offered to change the small town’s name to Amazon. Other officials put their money where their mouth is and offered very large economic incentives—Maryland topped the list with $8.5 billion in tax and infrastructure incentives, with New Jersey in second place with $7 billion of incentives.

While the magnitude of many of these incentive packages was unprecedented, the practice of state governments using taxpayer funds to reward for-profit companies for maintaining or expanding their operations within the state is not new. All 50 state governments have economic development agencies and/or commerce departments focused on growing their state’s economy, primarily by retaining existing and generating new jobs in their state. These agencies’ budgets are generally established through the state budgetary procedure (which involves the state legislature and gubernatorial office) and operate as either a division within the governor’s office or as a quasi-governmental agency overseen by either the governor’s office or state legislature (or both). In the fiscal year 2016, state economic development agencies’ budgets were approximately $4 billion.

Economic incentive awards have grown in frequency and economic magnitude over time, with a New York Times article noting that for state governments, “incentives have become the cost of doing business with almost every business.” The majority of state economic incentives relate to tax credits, abatements, and rebates spanning all types of business taxes (e.g., income, property, payroll, sales/use, etc.). Other types of incentives include cost reimbursement programs, grants, and forgivable loans. Recipients of multi-million dollar state economic incentives beyond Amazon include other well-known companies such as Berkshire Hathaway, Boeing, Exxon Mobil, FoxConn, General Motors, Nike, Royal Dutch Shell, Sasol, Toyota, and Volkswagen.

Critics of corporate economic incentives view these awards as the product of “pay-to-play” policies that favor corporations with political connections, with some noting that corporate economic incentives are “antithetical to the idea of free markets” and the “result of insidious cronyism.” For example, when a close friend of then-New Jersey governor Chris Christie oversaw the New Jersey Economic Development Authority, more than $1 billion in corporate economic incentives were awarded to 22 companies—21 of which had close ties to Governor Christie and the Republican Party.

A recent study by Ernst & Young notes that “governors and economic development leaders increasingly have access to more closing funds, which can not only speed the process but also lead to some flexible or creative opportunities.” The largest economic incentive packages generally require special approval from a state’s governor and/or legislature. For example, the Texas Enterprise Fund (“TEF”) was created by the Texas state legislature in 2004 at then-Governor Rick Perry’s request and is administered by the Economic Development and Tourism division of the Office of Texas Governor. TEF “serves as a financial incentive for those companies whose projects would contribute significant capital investment and new employment opportunities to the state’s economy,” and has awarded nearly $700 million in “deal-closing grants” to date. One in three recipient companies contributed financially to either Perry or the Republican Governor’s Association (an organization Perry served as Chairman of) in the first eight years of TEF’s existence.

Political Connections and Effective Allocation

Even if there is a systematic positive relation between corporate political connections and state economic incentive awards as critics suggest, constituents should be most interested in whether such connections reduce or enhance the effective allocation of state government resources. These incentives are awarded with the intent to stimulate the local economy through job growth, so the most effective awards should generate the greatest increase in targeted and spillover job growth. Theoretical work suggests government incentives awarded to politically-connected firms are an ineffective allocation of government resources, as funds may be allocated to a project on factors other than project merits. Others suggest political connections reduce information asymmetries between politicians and companies, which leads to better project identification and more effective allocation of government resources.

Our paper Political Connections and Government-Awarded Economic Incentives: US State-level Evidence examines the role of political connections in US state government-awarded corporate economic incentives, and whether a role (if present) is cause for constituent concern. State-awarded corporate economic incentives data are provided by Good Jobs First (Subsidy Tracker 3.0 dataset). We measure political connections using state-level political campaign contributions by corporations and their corporate-sponsored political action committees (data provided by the National Institute on Money in State Politics).

As a company is expected to be more likely to seek economic incentives and establish political connections in states with greater economic importance to the company’s operations, we need to measure a state’s economic importance to a particular company. We rely on corporate disclosures filed with the Securities and Exchange Commission (SEC) to construct this measure. As only publicly-traded companies are required to provide this information, our analyses focus on the nearly 1,000 public companies that receive at least one state government-awarded economic incentive from 2000 through 2014.

We find a robust positive relation between state-level corporate political connections and the likelihood of receiving a state-awarded economic incentive. In a given year, a company is nearly four times more likely to receive an economic incentive award in a state where the company makes political contributions to state-level political candidates, relative to in a state where the company does not. We also find that when a company does receive an economic incentive award, the incentive is 63 percent larger in a politically-connected state, relative to a politically-unconnected state. Companies contributing to both Republican and Democratic candidates, and to both gubernatorial and legislative candidates, have a higher likelihood of receiving an award and receive an award of a larger dollar value. We exploit unexpected gubernatorial departures due to deaths or ethical violations as a shock to a company’s political connections and find that the incentive award likelihood and amount are lower post-shock for companies with political connections to the departing governor.

“Our analyses indicate that US state economic incentives are disproportionately awarded to politically-connected companies, even though these awards appear to be a less effective use of taxpayer-provided funds.”

How companies Exploit Political Connections

We seek to shed light on whether the positive relation between corporate political connections and economic incentive awards reduces or enhances the effective allocation of government resources. We address this question from the perspective of the three key stakeholders: politicians, taxpayers, and corporate shareholders.

With respect to state politicians’ motives, we find that the positive relation between connections and incentives is stronger when state political corruption is greatest, and when a candidate’s political party is vulnerable to losing its majority position in the state legislature. Political corruption is assessed using the US Department of Justice data on annual public corruption convictions from the 94 US federal district courts, and state-years where the per-capita conviction rate is in the top decile of the sample are deemed to be corrupt. These analyses are consistent with the state incentive awarding process being influenced by politicians’ self-serving motives.

We next consider taxpayers’ interests by examining local future economic growth. State incentive awards are intended to stimulate the economy through job growth. Using county-level data on the location of the corporate facilities receiving the economic incentive, we find that incentives awarded to politically-unconnected companies generate greater within industry job growth, greater job growth spillover to other industries, and larger increases in the local house price index (our measure of aggregate economic growth beyond net jobs creation). The results suggest awarding economic incentives to politically-connected firms is a less effective use of taxpayer funds.

Finally, we consider shareholders’ interests. Within a sample of the largest incentive awards, we find that announcements of incentive awards to politically-connected companies generate a larger positive market reaction than announcements of awards to unconnected companies. This finding is consistent with shareholders expecting greater benefits to accrue to politically-connected companies for a given dollar of incentive award. Collectively, our analyses indicate that state economic incentives are disproportionately awarded to politically-connected companies, even though these awards appear to be a less effective allocation of taxpayer-provided funds.

Shareholders Need More Transparency

We believe these findings should be of interest to taxpayers funding governments that award economic incentives to the private sector. In addition, our findings should be of interest to multiple policymakers’ current deliberations. Both the Financial Accounting Standards Board and Governmental Accounting Standards Board have taken an interest in the disclosure of government-awarded economic incentives. In addition, a 2011 SEC rule-making petition urging the agency to mandate disclosure of corporate political activity has received more than 1.2 million public comments to date, and shareholder resolutions seeking information on political-related expenditures ranked first on proxy discussion topic lists in 2018. Our findings speak to the importance of transparency and more granular public disclosures by companies regarding economic incentive awards received and political contributions made, and by state and local governments regarding which firms are receiving economic incentive awards each year.

Unfortunately, there does not seem to be a legislative or regulatory movement towards increased corporate transparency anytime soon. On the legislative front, the Corporate Political Disclosure Act of 2019 that was introduced in the House of Representatives in February 2019 seems promising. This legislation would require publicly-traded companies to disclose all political activity expenditures on an annual basis. However, the proposed bill has yet to be discussed by the House Committee on Financial Services, and the legislation was originally introduced in a prior congressional session but never made it out of this same committee.

How can the SEC “make sure shareholder democracy creates long-run value for ordinary American investors?” Commissioner Robert J. Jackson Jr. examines the recent proposal on regulating proxy advisors & says it shields CEOs from accountability to investors: https://t.co/SuPHD6PwVW pic.twitter.com/08DgmBatvP — Stigler Center (@StiglerCenter) November 13, 2019

On the regulatory front, the SEC’s recent proposed modifications to Securities Exchange Act Rule 14a-8 increases requirements for shareholder proposals to reach firms’ proxy statements. The proposal increases shareholders’ economic holding requirements to submit a proposal for inclusion in corporations’ annual proxy statements, and raise thresholds for shareholder proposal resubmissions. As previously noted in a ProMarket piece, the SEC’s own economic simulation indicates that these modifications will exclude 40 percent of political spending disclosure proposals. This SEC proposal is open for public comments through February 3, 2020. We look forward to seeing developments on these important legislative and regulatory issues.

Daniel Aobdia is an Associate Professor of Accounting Information & Management at the Kellogg School of Management at Northwestern University. Allison Koester is the Saleh Romeih Associate Professor of Business Administration at the McDonough School of Business at Georgetown University. Reining Petacchi is the Dottie and Tim Hobin Associate Professor of Business Administration at the McDonough School of Business at Georgetown University.

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