Two Essays on Politics and Finance

I examined how politics affects corporate policies and value in two dissertation essays. In my first essay, we investigate whether diversity in points of view within corporate boards, as captured by the diversity in political ideology of board members, can affect a firm's performance. We employ personal political contributions' data to measure political ideology distance among groups of inside, outside directors and the CEO. Our empirical evidence strongly supports the notion that outside directors' monitoring effectiveness is more likely to be enhanced when their viewpoints are distinct from those of management. We find that ideologically diverse boards are associated with better firm performance, lower agency costs and less insiders' discretionary power over the firm's Political Action Committee (PAC) spending. Taken together, our results lead us to conclude that multiplicity of standpoints in corporate boardrooms is imperative for board effectiveness. In my second essay, we document that firms surrounded by high degrees of policy risk generated by local politicians' legislative activities present significantly high stock returns, indicating investors' perception of policy risk. We find that the diverse political strategies firms implement 1) successfully mitigate such policy risk, 2) help firms to acquire more lucrative procurement contracts, and 3) even get firms in trouble with legal issues. Additional results reveal that poor stock performance related to litigation is significantly recovered by political connections. Overall, our results reflect that investors view corporate political activities as effective hedging strategies against policy risk. Collectively, politics plays a critical role in determining corporate policies and/or value.