Politically Connected Governments

• Author: MIHIR N. MEHTA,JUNGBAE KIM,CHRISTINE CUNY
• DOI: http://doi.org/10.1111/1475-679X.12325
• Date: 01 September 2020
• Published date: 01 September 2020

DOI: 10.1111/1475-679X.12325

Journal of Accounting Research

Vol. 58 No. 4 September 2020

Printed in U.S.A.

Politically Connected Governments

CHRISTINE CUNY ,∗JUNGBAE KIM ,†

AND MIHIR N. MEHTA ‡

Received 18 July 2018; accepted 10 March 2020

ABSTRACT

This paper examines the consequences of powerful political connections

for local governments. We find that governments located within the con-

stituencies of, and thus connected to, powerful congressional members re-

duce their stewardship over public resources. Using plausibly exogenous de-

clines in the power of congressional representation, we show that the effect

is causal. To better understand why connected local governments can reduce

stewardship, we study electoral characteristics. Our findings suggest that the

increased resources that come with powerful congressional representation al-

low local-government officials to reduce stewardship without material adverse

effects on their reelection prospects. In sum, we provide evidence of a cost of

∗New York University; †Singapore Management University; ‡University of Michigan.

Accepted by Christian Leuz. We are grateful for suggestions from an anonymous reviewer,

Beth Blankespoor,Hans Christensen, Anna Costello, Wayne Guay, Rick Hall, Raffi Indjejikian,

Venky Nagar,Anya Nakhmurina, Sugata Roychowdhury (discussant), Stephen R yan, Marshall

Vance, Joseph Weber, and Frank Zhou. We also thank participants at the Colorado Accounting

Research Conference, London Business School Trans-AtlanticDoctoral Conference, New York

University Summer Camp, Stanford University, University of Chicago, University of Michigan,

University of Pennsylvania, and University of Washington for helpful comments. We thank

Rohit Singla and DJ Stockbridge for research assistance. M. N. Mehta acknowledges funding

from the Paton Accounting Center at the University of Michigan. This paper was previously

circulated under the title “Friends in high places: An examination of politically connected

governments.” An online appendix to this paper can be downloaded at http://research.

chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

915

CUniversity of Chicago on behalf of the Accounting Research Center, 2020

916 C.CUNY,J.KIM,AND M.N.MEHTA

political connections: they weaken local governments’ incentives to act in a

socially optimal manner.

JEL codes: G18; G38; H1; H7; H83; M40; M42

Keywords: governance; stewardship; political economy; financial reports;

congress; political connections; audit

1. Introduction

U.S. local governments (i.e., cities and counties) oversee substantial re-

sources that they use to provide essential public services, such as water,

sanitation, emergency response, roads, and education.1Ineffective man-

agement of these resources can have adverse effects on local citizens’ wel-

fare and local economic development (Wolfensohn [1996], Ugur and Das-

gupta [2011]). Thus, it is important to understand the factors that affect

local governments’ stewardship, which we define as their efforts to oversee

and appropriately deploy public resources.

One factor that can affect a local government’s stewardship is the power

of its representation in Congress (i.e., its political connectedness).2Mem-

bers of Congress maximize their chances of reelection by channeling fed-

eral resources and policy benefits to their constituents (Shepsle and Wein-

gast [1994]). As a member rises to power in Congress, the magnitude and

breadth of the benefits that they allocate to their constituency grows, di-

rectly and indirectly increasing the resources available to local governments

within the constituency (e.g., Cohen, Coval, and Malloy [2011]). This sur-

plus of resources could influence local governments’ governance efforts.

In this paper, we examine whether and how local government stewardship

changes in the presence of powerful congressional representation.

Ex ante, the effect of powerful congressional representation on local gov-

ernments’ stewardship is unclear. On the one hand, stewardship may be

weaker when the local government is connected to powerful congressional

members. Preferential access to federal resources and the resulting im-

provement in the quality of services for local citizens could decrease voters’

attention to stewardship. In turn, reduced voter attention to stewardship

can reduce both local government officials’ incentives to supply steward-

ship and congressional members’ incentives to demand stewardship from

their connected local governments.

On the other hand, local government stewardship may be stronger when

the government is connected to powerful congressional members. These

1Commensurate with their important role, local governments were responsible for spend-

ing over $1.5 trillion of government funds in 2015. To put this amount into perspective, con-

sider that in the same year,U.S. federal government revenues were approximately $3.4 trillion.

2Local governments are “politically connected” to members of Congress in the sense that

they both represent the same constituents. Thus, we use the terms “connection” and “repre-

sentation” interchangeably throughout the paper.

POLITICALLY CONNECTED GOVERNMENTS 917

local governments are likely subject to greater scrutiny in the form of gov-

ernment audits and media attention. Higher quality stewardship reduces

negative publicity and political challengers’ ability to argue that incumbent

politicians are misusing resources (Brender [2003], Brender and Drazen

[2008]).

Our basic concept of stewardship is the proper oversight and use of pub-

lic funds. To operationalize this concept, we introduce a novel measure

of stewardship. The Governmental Accounting Standards Board (GASB)

highlights that financial and control system audits help local governments

demonstrate “accountability to constituents, including stewardship over

public resources.” In this spirit, we measure stewardship as the first prin-

cipal component of five metrics from local governments’ audits.3

Using a sample of 56,042 observations between 1999 and 2016 that repre-

sent 7,166 unique local governments, we show that local governments’ stew-

ardship declines in the presence of powerful congressional representation.

In economic terms, a one-standard-deviation increase in the strength of

a local government’s representation on the most influential congressional

committees correlates with a 1.8–2.6% decline in each of the five compo-

nents of stewardship.4

To establish causality, we use powerful politicians’ unexpected depar-

tures from Congress (due to either sudden death or cabinet appointment)

that dramatically decrease the power of connected local governments’ rep-

resentation in Congress. The sudden departure of a powerful member re-

duces the federal benefits available to local governments in their district (or

state) and increases these governments’ incentives to improve oversight of

their more limited resources. We show that following an unexpected de-

parture, connected local governments improve the stewardship of their re-

sources. The evidence indicates that the power of congressional represen-

tation causally affects local governments’ stewardship.

We also investigate channels through which the inverse relationship

between stewardship and powerful congressional representation can

manifest. In particular, reduced stewardship in the presence of a powerful

connection could be driven by intentional, nefarious efforts by local

government officials to misappropriate funds for personal gain. It could

also be driven by ineptitude, leading to the unintentional misuse of funds.

Our cross-sectional evidence is consistent with misappropriation; we find

that the negative link between powerful congressional representation and

3The five metrics are: (1) an unmodified audit opinion, (2) no material weakness in control

systems, (3) no significant deficiency in control systems, (4) no material noncompliance with

applicable laws and regulations, and (5) the speed with which the auditor completes the audit.

The coefficient of interest is similar in magnitude and the inference is the same using several

alternative measures of stewardship.

4We present economic significance using the individual components of local government

stewardship because our summary measure of stewardship is mean-zero, which makes it diffi-

cult to meaningfully interpret.