Friends in Low Places : The Impact of Political Scandals on Connected Firms’ Stock Prices

Prior literature suggests that capital market participants reward firms’ political connections. More recently, shareholders and scholars have argued that political affiliations may also inflict reputational risk on firms when the connected politician is involved in dubious activities or shares ideologies that are not in line with company values. To study the costs of such connections, I analyse the abnormal returns of firms that contribute to politicians around a hand-collected sample of 218 political scandals. Scandals are exogenous shocks to investors’ perceptions of politicians and their close affiliates and returns to scandals may thus be a first indication of the expected consequences that come with backing controversial politicians. My results show that connected firms experience negative abnormal returns when scandals involve other firms or lobbyists. Further analyses indicate that the reaction is not primarily driven by an expected loss in political benefits, but by reputation spillover and investors updating their beliefs about the risks inherent in political contributions