Political corruption shielding and corporate acquisitions

• Author: Lawrence Kryzanowski,Ashrafee Tanvir Hossain
• Date: 01 February 2021
• DOI: http://doi.org/10.1111/fire.12247
• Published date: 01 February 2021

DOI: 10.1111/fire.12247

ORIGINAL ARTICLE

Political corruption shielding and corporate

acquisitions

Ashrafee Tanvir Hossain1Lawrence Kryzanowski2

1Faculty of Business Administration,

Memorial University of Newfoundland, St.

John’s, Newfoundland and Labrador,Canada

2Department of Finance, John Molson School

of Business, Concordia University,Montreal,

Quebec, Canada

Correspondence

LawrenceKryzanowski, Department of

Finance,John Molson School of Business,

ConcordiaUniversity, 1455 de Maisonneuve

BlvdWest, Montreal, QC H3G 1M8.

Email:lawrence.kryzanowski@concordia.ca

Fundinginformation

SeniorConcordia University Research Chair

inFinance; Memorial University of Newfound-

land;Social Sciences and Humanities Research

Councilof Canada, Grant/Award Number:

435-2018-048

Abstract

Corruption includes rent-seeking behavior by public offi-

cials (e.g., lavish in-kind benefits and monetary kickbacks

for contracts/permits/regulatoryleniency, improper political

contributions/support, etc.) that can negatively affect firm

valuations, performances, and strategic choices. Shielding

strategies are used to diminish rent-seeking attractiveness

of firms. Acquisitions provide a better channel than cash or

leverage for assessing the wealth effects of shielding strate-

gies. We find that the mean 3-day announcement returns

for acquirers for a large sample of U.S. domestic acquisitions

between 1990 and 2014 is significantly lower for firms head-

quartered in relatively higher corruption states. Our results

survive an array of robustness tests.

KEYWORDS

M&As, political corruption, political favor(s), shielding, state and

local government

JEL CLASSIFICATION

D73, G30, G34, H70

1INTRODUCTION

Political corruption (“corruption”henceforth) has a long historical footprint. Based on World Bank Enterprise Surveys

(http://www.enterprisesurveys.org/data/exploretopics/corruption), one in five companies worldwide receive at least

one request for a bribe payment, and almost one out of three are expected to provide gifts to secure government

contracts. Though giving or taking bribes is not legally allowed in the United States, rent-seeking behavior bycorrupt

politicians and public officials continues to flourish, arguably in a more sophisticated manner.The best and worst rank-

ing achieved by the United States over a 10-year period (2009–2018) using the Corruption PerceptionsIndex (CPI)

published by TransparencyInternational is 16th in 2015 and 2017, and 24th in 2011, respectively.

Financial Review. 2021;56:55–83. wileyonlinelibrary.com/journal/fire ©2020 The Eastern Finance Association 55

56 HOSSAIN ANDKRYZANOWSKI

Studies show that corruption can havenet negative effects if political corruption merely represents a harmful form

of taxation without compensating benefits (Shleifer & Vishny, 1993), which, in turn, can negatively affect the valua-

tions, performances, and strategic choices of firms (e.g., Brown, Smith, White, & Zutter, 2019; Dass, Nanda, & Xiao,

2016; Hossain & Kryzanowski, 2020; Shleifer & Vishny,1993;Smith,2016).1Although this literature generally relates

political corruption with ex ante political connections, we follow the literature and use various ex ante and ex post

measures of political corruption, such as for enforcement (attempted or actual convictions), political codes of ethics,

and perceptions of interested observerssuch as the media that can vary geographically (e.g., Dass et al., 2016; Parsons,

Sulaeman, & Titman, 2018;Smith,2016).

Corruption includes rent-seeking either initiated or agreed to by public officials or employees. This rent-seeking

includes the solicitation or acceptance of lavish in-kind benefits and monetary kickbacks for the granting of contracts

or permits or licenses, for taking a particular position on a specific piece of legislation such as the imposition of tariffs

that favors a firm’s industry from foreign competition, and regulatory or tax leniency.It also includes requests for or

acceptances of improper monetary and in-kind political contributions. An exampleis a rent-seeking conviction in 2014

that was later vacated in 2016 by the United States Supreme Court.2This case involved Robert McDonnell, a former

governor of Virginia, and his wife for accepting more than $170,000 in loans and gifts (e.g., Rolex watch, vacations,

partial payments for a daughter’s wedding reception) from the CEO of Star Scientific who wanted state universitiesto

perform important clinical tests on a dietary supplement developed by the company (Barnes, 2016). Shielding strate-

gies such as low cash, high leverage, relocation to a jurisdiction with lower political corruption, and acquisitions are

used to make firms less attractive to rent seekersby increasing firms bargaining power with rent seekers (Svensson,

2003). As rent seekers tend to target firms based on their capacity to pay(Stulz, 2005), firms are less attractive if they

reduce their current liquidity through lower cash balances or their future discretionary liquidity by increasing cash-

flow commitments through increased leverage or distribute their revenue-generatingassets over multiple locations.

Firms also are less attractive for rent seekers if theyacquire other firms with cash or debt financing or in other juris-

dictions with lower political corruption.

Although Smith (2016) identifies four channels by which firms could shield against political rent-seeking (cash

balances, leverage, relocations, and acquisitions), his evidence was essentially confined to a robust demonstration

that firms have lower cash balances and higher leveragesin more corrupt environments, which is indirectly consistent

with their use to shield against rent-seeking. However, Smith does not provide evidenceon the effect on firm value

of using lower cash balances and higher leverages in more corrupt environments. Our paper provides a further test

of Smith’s Shielding Hypothesis against rent-seeking using the channel of acquisitions, which provides a convenient

test of firm-value effects. Specifically, we investigate whether local (state-level) political corruption affects the

shareholder wealth of acquirers as reflected in announcement period returns (cumulative abnormal returns [CARs]).

Our analyses are grounded in two associated expectations. First, if a rational manager in a corrupt environment

uses acquisitions as a tool to shield against rent-seeking, they will do so as long as the net benefit of shielding

is positive; therefore, we expect that the CARs for corrupt-place acquirers will be positive. Second, the market-

assessed net benefits of acquisitions reflected in acquirer CARs in more corrupt environments due to the lower

bargaining power of the acquirer (e.g., due to less “informational transparency” as found by Dass et al., 2016) should

be lower than that for acquirers in less corrupt environments. Tosummarize, we expect that an average high-corrupt-

place acquirer experiences a nonnegative return that will be lower than its average low-corrupt-place acquirer

counterpart.

1Some studies find benefits of illegal behavior, which maynot be explicit, by political participants if firms can deal in a more cost-effective manner with

bureaucratic rules or rent-seeking (e.g.,Borisov, Goldman, & Gupta, 2016; Faccio, Masulis, & McConnell, 2006; Khwaja & Mian, 2005). Rent seekers aim to

obtainfinancial gains and/or benefits by altering the distribution of economic resources.

2The Court’s decision on page 28 stated that: “There is no doubt that this case is distasteful; it maybe worse than that. But our concern is not with tawdry

talesof Ferraris, Rolexes, and ball gowns. It is instead with the broader legal implications of the Government’s boundless interpretation of the federal bribery

statute.”McDonnell v. United States, 579 U.S. ___(2016).