Sunday, January 13, 2013
The social cost of political connections
As I told my audiences this week in Chile, there is increasing evidence (in the US, Spain, France and Italy), that the common practice of appointing former politicians in the board of directors of large firms is negatively correlated with the value of these firms. A possible explanation of this (which requires further inquiry) is that managers use their discretion to make mistakes due to behavioral biases, in the absence of immediate feedback from their actions. For example, they recruit politicians because of an availability bias or an attribution bias. One could stop here, and think that since it is a strategic mistake by firms, it will not have any cost for society at large. One could think that if firms do not create any value for shareholders with these actions, it means that they do not succeed in using former politicians to capture public policies in their favour. However, that may be in the short run. In the long run, to the extent that some of the firms in which political connections are more widespread belong to regulated sectors, the cost for the firm of its mistakes may end up spilling over consumers and tax payers. That is because in regulated sectors (such as network or financial industries), regulators may be dragged towards covering the losses of the badly managed firms or even bailing them out, as has been notorious with many financial institutions in the recent past. And of course, there is a cost in terms of creating an increasing distance between politicians and voters.