It is a Sweetheart of a Deal: Political Connections and Corporate‐Federal Contracting

Date01 February 2019
Published date01 February 2019
The Financial Review 54 (2019) 57–84
It is a Sweetheart of a Deal: Political
Connections and Corporate-Federal
Stephen P. Ferris
University of Colorado, Colorado Springs
Reza Houston
Ball State University
David Javakhadze
Florida Atlantic University
We examine whether political connections measured by political contributions influence
the choice of terms included in government contracts awarded to firms. We construct an index
of four “sweetheart” contract terms and find that firms making larger political contributions
more frequently have these favorable terms included in their contracts. We also find that po-
litical contributions have explanatory power for contract design after controlling for lobbying,
negotiation power, and the employment of former government employees. These results are
robust to alternative model specifications, different estimation techniques, various variable
measurements, and adjustments for possible endogeneity.
Keywords: contracting, political connections
JEL Classifications: G32, G38, GT34
Corresponding author: College of Business, University of Colorado, Colorado Springs, CO 80918;
Weare grateful for the helpful comments and suggestions by the participants of the 2017 Southern Finance
Association Annual meeting. We also thank the Center for Responsive Politics for providingthe data on
C2019 The Eastern Finance Association 57
58 S. P.Ferris et al./The Financial Review 54 (2019) 57–84
A sweetheart deal or sweetheart contract is an abnormally favorable contractual
1. Introduction
A growing literature in finance and economics examines the role of political con-
nections on business behavior and value. Political connectedness can improve access
to government resources and consequently benefit the firm. Existing research shows
that political connections influence corporate acquisition activity (Ferris, Houston
and Javakhadze, 2016), litigation process and outcomes (Abdulmanova, 2016), Se-
curities and Exchange Commission enforcement (Correia, 2013), access to capital
and loan pricing (Claessens, Feijen and Laeven, 2008; Infante and Piazza, 2014),
and stock returns (Cooper, Gulen and Ovtchinnikov, 2010). Alternatively,the intense
competition for government contracts can produce an equilibrium where the govern-
ment receives financial gains, aggravatesagency problems within a firm, and reduces
long-term corporate performance (e.g., Dixit, Grossman and Helpman, 1997; Fan,
Wong and Zhang, 2007).
In this study, we expand the contracting literature by investigating the potential
impact of political connections on federal contracting. More specifically,we examine
whether the presence of political connections extends beyond influencing the awardof
government contracts as reported by Goldman, Rocholl and So (2013) and affects the
contract terms themselves. That is, we explore whether a firm’s political connections
result in the inclusion of contract terms that are highly favorable to the firm and
less apparently so for the government. To undertake our analysis, we construct an
index of four contact terms that we believe are highly favorable to the firm, but not
obviously advantageous to the government. We refer to this index as the “sweetheart
index” since it reflects the extent to which the contract is a “sweetheart” deal. We
then examine the extent to which a firm’s political connections influence the level of
this index.
Our empirical analysis undercovers a number of important relations between
political connections and contracting activity. We confirm that politically connected
firms receive more government contracts. More importantly, we find that the likeli-
hood of “sweetheart” provisions in federal contracts is increasing in political contribu-
tions. We further show that campaign contributions continue to possess explanatory
power after controlling for other political activities such as lobbying and the em-
ployment of former government employees. Our results suggest that Political Action
Committee (PAC) donations provide a unique channel for social connections and the
mutual exchange of favors between a firm and government officials. Our findings
are robust to various model specifications, estimation techniques, and alternative
measurements of key variables.
We use several strategies to overcome possible endogeneity challenges. First,
we follow Akey (2015) and examine the effects of donations made to winning and

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