Achieving Business Success in Times of Uncertainty? Ramp Up Your Lobbying

We know companies have a reason to open offices on K Street in Washington, D.C.: Having the ear of politicians may steer policy in ways that benefit your business, and it could also help you get early notice of policy decisions that will affect the company’s bottom line or unveil new opportunities.

But measuring how “political activism” — which includes lobbying for your company, or simply getting involved in policy discussions — will translate into actual market power is hard.

“Market power is your ability to charge a price that's higher than what you would charge with perfect competition,” said Elia Ferracuti, an associate professor of accounting at Duke University’s Fuqua School of Business. “Is political power correlated to market power?”

In a paper accepted for publication in the Journal of Financial and Quantitative Analysis, Ferracuti and colleagues (Roni Michaely of Hong Kong University and Laura A. Wellman of University of Oregon) analyzed the political activism of thousands of firms between 1993 and 2017.

By adopting novel measures of elusive concepts such as political activism, policy uncertainty, and market power, they found that companies engaged in political activism at times of policy uncertainty gain market share, especially larger firms that can afford higher investments on these strategies.

“Having an office on K Street gives you a better ability to both understand and influence legislative developments,” Ferracuti said. “While the average firm is damaged by uncertainty, politically active firms will be able to amass market power and market share.”

How to measure company “political activism”?

There are many “political actions” a company can deploy to gain an informational advantage, Ferracuti said. They might donate to campaigns, make political contributions, or hire lobbyists.

“But that's just the tip of the iceberg,” he said.

While researchers can generally track these activities (at least for public companies), many other lobbying interactions mostly happen behind closed doors, he said.

“Companies engage in conversations with policymakers, because policymakers are interested in getting feedback from them, or because corporations want to better understand certain legislation,” he said. “All these activities are largely unobservable.” 

Despite this limited access to information, Ferracuti and colleagues hypothesized that just having a government relations office in D.C. may be a good proxy for political activism.

“Having an office in DC is a way to measure a firm’s overarching political activity,” he said. “We don't need to know whether they are having conversations with politicians or are organizing events. The government relations office summarizes all those unobservable activities.” 

As a second proxy for political activism, the researchers measured the “power of politicians” supported by firms’ campaign contributions. An elected politician belonging to a party with more voting power at any given time has more political power, the researchers assumed. Using campaign finance disclosures, Ferracuti and colleagues matched campaign contributions to politician names and parties and were able to assign a value of higher political activism to those firms that contributed to more powerful politicians.

Measuring “policy uncertainty”

The researchers assumed that lobbying may give companies a particular advantage at times of policy uncertainty.

Policy uncertainty is about the rules of the game, Ferracuti said. If certain companies think, for example, that merging with rivals in a particular market may be looked down upon by regulators, then they may want to hold back on that action, Ferracuti said.

In such situations, a company could decide to increase its lobbying efforts to gather information on the government’s next move — a strategy that could become especially useful with tariff policy uncertainty, for instance.

But how do you measure policy uncertainty? For this, the researchers borrowed the Economic Policy Uncertainty (EPU) index, an indicator that tracks the frequency of newspaper references to “economic policy uncertainty” across thousands of newspaper publications.

By collecting data on companies' investments in their government relations offices and matching these investments with periods of high policy uncertainty, the researchers could then investigate whether companies that increase their political activism — at times when those efforts can make a difference — actually gain a market advantage.

Market power in times of policy uncertainty

The researchers studied data on almost 8,000 public companies between 1993 and 2017 

A company’s “market power” is not easy to measure, Ferracuti said.

“Let's say you are a customer, and you can buy a product from many different companies. Then these companies could charge, say, 100. Now, if instead you can buy that product only from me, I can charge a higher price, let's say 120,” Ferracuti said. “That difference of 20 would indicate market power.”

The researchers tested market power by studying quarterly data on companies’ margins, producer prices, and “markup” (roughly, the price a company can charge for a product in excess of its costs).

In general, they found that roughly doubling the number of employees in the government relations office is associated with a 3% increase in margins following periods of policy uncertainty. This market power creates barriers to entry for less politically active companies (usually smaller firms), which tend to create fewer jobs and often have to exit the market, the researchers write.

These results held true with tariff policy uncertainty, Ferracuti said. As tariffs reduce competition from foreign companies, the researchers tested whether tariff uncertainty would affect the “penetration” of imported products. Consistently, they found that politically active firms experience lower competition from imports during times of trade policy uncertainty, meaning that their lobbying efforts lead to market power over foreign competitors.

Instability shifts success to large firms, away from small businesses

As U.S. market power seems to have shifted into the hands of fewer companies (and with shrinking numbers of small, profitable companies), this research sheds light on political activism as one of the possible contributing factors, especially at times of policy uncertainty, Ferracuti said. 

“Policy uncertainty can be detrimental to firm decision-making, but the cost of uncertainty will affect certain firms more than others,” he said. “When you don't know what's going to happen, large firms will benefit because they have a seat at the table, and that gives them better information and better influence.”

In an ideal world, Ferracuti said, policymakers should avoid frequent policy changes because stability allows companies to plan and make better decisions.

“Instability, on the other hand, creates a redistribution of success from small firms to large firms, which have more resources to influence policy,” he said.