THE LION’S SHARE: EVIDENCE FROM FEDERAL CONTRACTS ON THE VALUE OF POLITICAL CONNECTIONS Şenay Ağca, GWU Deniz Igan, IMF September 8, 2015

Motivation  Value of political connections  Long-standing question  Empirically challenging to establish the direction of causality  An exogenous shock  September 11 and the start of the war in Afghanistan on October 7, 2001 Direct impact on defense spending Nondefense spending treated as control case

Outline  Some background  Brief literature  Federal budget and procurement processes  Empirical set-up  Measuring political connections  Research design  Findings  Interpretation

Literature Budget and Procurement Background

Are political connections valuable…  Important question for welfare and policy setting, with macroeconomic implications  Engagement and policy stability, adaptability, and coordination (long list)  Evidence on politically connected firms  Better economic performance and stock market value (Fisman 2001, Faccio 2006, Goldman et al 2009, Cooper et al 2010)

…and why?  Reverse causality is a problem, so is the channel  Quid-pro-quo?  Preferential access to finance (Khwaja and Mian 2005, Claessens et al 2008)  Bailout (Faccio et al 2006, Duchin and Sosyura 2012)  Contracts (Goldman et al 2013, Tahoun 2014)  Access?  Whom you know or what you know (Bertrand et al 2014)  Losing congressional connection means losing revenue (Blanes-Vidal et al 2012)

Our contribution  Direction is from political connections to contracts  Address reverse causality / endogeneity issues from contracts to political connections  Channel can be quid-pro-quo or access  Put a number on the value of connections  Compare different ways to establish connections

Budget process  Agencies submit their requests to the Office of Management and Budget (OMB) between September and December (e.g. September- December 2001)  The President submits the budget to Congress in February (e.g. February 2002)  Congress passes a budget resolution and approves funding for discretionary spending – fiscal year starting in October (e.g. October 2002)

Procurement process Budget formulation Legislative action Actual execution

Procurement process  Pentagon covered by:  DoD Appropriations Bill  Military Construction Appropriations Bill  Acquisition personnel post solicitation on FedBizOpps and evaluate the offers in accordance with Federal Acquisition Regulation  All awards reported for public transparency on Federal Procurement Data System

Data Design Empirical set-up

Data  Federal contracts  Center for Effective Government (an OMB watchdog)  Focus on DoD versus other (Agriculture, Energy, Health, etc)  Only corporations and awards > $200K  Political connections  Lobbying Senate Office of Public Records Semiannual reports  Campaign contributions Federal Election Commission PAC contributions to winning candidates  Board connections Boardex Connections to armed forces

Research design Pre-event period Budget request: Sep–Dec 1999 Approved funds for: Oct 2000– Sep 2001 Lobbying in: Jan–Dec 1999 Campaign in: 1998 election cycle Event period Budget request: Sep–Dec 2000 Approved funds for: Oct 2001– Sep 2002 Lobbying in: Jan–Dec 2000 Campaign in: 2000 election cycle Post-event period Budget request: Sep–Dec 2001 Approved funds for: Oct 2002– Sep 2003 Lobbying in: Jan–Dec 2001 Campaign in: 2000 election cycle

Differences in differences  Main question: Do politically connected firms get larger contracts when available funding increases?  Two treatment effects  Defense versus nondefense contracts  Politically connected versus unconnected  Regressions: (1)Contract it = β 1 *Connection it + β 2 *Connection it *Postevent t + n i + y t + ε it (2)Contract it = β 1 *Connection it + β 2 *Defense it + β 3 *Connection it *Postevent t + β 4 *Defense it *Postevent t + β 5 *Defense it *Connection it + β 6 *Defense it *Connection it *Postevent t + n i + y t + ε it

Main results Interpretation Findings

Defense budget authority and outlays increased substantially 2002 onwards Discretionary Spending (billion dollars)

Both defense and nondefense firms somewhat intensified political activities LOBBYINGPre-eventPost-eventDifference Defense Nondefense ** Difference0.26***0.27***0.01 CAMPAIGN CONTRIBUTIONS Pre-eventPost-eventDifference Defense Nondefense Difference

Average defense contract size increased substantially more for lobbying firms Defense firmsPre- event Post- event Diff. Lobbying *** Non-lobbying *** Difference0.88***2.40***1.52*** Lobbying Non-lobbying

The difference is economically meaningful  Lobbying firms receive 92 percent larger defense contracts after the event than firms that are not lobbying  For defense firms, spending an extra $1 for lobbying brings in $2.5 in contracts after the event Defense onlyNondefense onlyPooled Lobbying * Postevent*Lobbying0.0496*** Defense* Lobbying ** Postevent*Defense0.0618*** Postevent*Lobbying*De fense ***

Similar picture for campaign contributions Pre- event Post- event Diff. Contributing Non-contributing Difference2.20***2.75***0.55** Contributing Non-contributing

but not significant in regression analysis Defense onlyNondefense onlyPooled Campaign Postevent*Campaign * * Defense* Campaign *** Postevent*Defense Postevent*Campaign* Defense  Firm fixed effects take away the difference

Board connections significant, statistically… Pre- event Post- event Diff. Connected board ** Unconnected board *** Difference0.78**1.42***0.91*** Connected board Unconnected board

…and economically  Median defense contract size is $1.3 million  Firms with connected boards get $2.5 million after the event  Firms with no board connections get $1.36 million Defense only Board connection Postevent0.0423*** Postevent* Boardconnection **

Joint specification DefenseNondefensePooled Lobbying **0.0140*0.0137* Post-event*Lobbying0.0641*** Campaign Post-event*Campaign *** Board connection Post-event*Board connection0.505* 0.506* Lobbying*Defense *** Post-event*Lobbying*Defense *** Campaign*Defense * Post-event*Campaign*Defense Post-event*Defense ***  Lobbying and board connections continue to have a positive effect on the contracts granted when considered jointly – they are compliments (not substitutes)

Defense contracts - excluding top 10 contractors  Results are not driven solely by top contractors LobbyingCampaignBoard connection Lobbying ** Post-event*Lobbying0.0528*** Campaign Post-event*Campaign Board connection Post-event*BoardConnection 0.631**

Placebo period  October 2004-September 2007  Iraq war has started in March 2003 – increased defense spending has been ongoing during this period  No additional major event that should affect defense contracts October 2004-September pre-event October 2005-September 2006 – event October 2006-September post-event  No robust and significant effects of political activism

Checks  Using indicators instead of amounts – results are robust  Comparing defense to nondefense  Controls for any trends in connections and contracts  Visually no difference in pre- and post-event contract amounts for nondefense  Coefficients on Postevent*Connection are insignificant in nondefense only sample  Coefficients on Postevent*Connection*Defense are significant in the pooled sample

Summary and interpretation  Exploit September 11 as an exogenous event that increased available government funding  Political connections (through lobbying and connected board members) help secure a larger share  Address the reverse causality / endogeneity problem, put a value to political connections, and compare alternative political connections  Channel can be quid pro quo or access – we cannot differentiate between these two channels

Further work  Connections to legislators?  Differentiate between connection and expertise?

Questions, comments welcome. Thank you.