The CEO as chief political officer: Managerial discretion and corporate political activity

JBR-08387; No of Pages 8 Journal of Business Research xxx (2015) xxx–xxx

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Journal of Business Research

The CEO as chief political officer: Managerial discretion and corporate political activity Michael Hadani a,⁎, Nicolas M. Dahan b, Jonathan P. Doh c a b c

School of Business and Economics, Saint Mary's College of California, 1928 Saint Mary's Road, Moraga, CA 94556, United States Fox School of Business, Temple University, 1801 N Broad St, Philadelphia, PA 19122, United States Villanova School of Business, Villanova University, 800 E. Lancaster Avenue, Villanova, PA 19085, United States

a r t i c l e

i n f o

Article history: Received 25 September 2013 Received in revised form 26 March 2015 Accepted 28 March 2015 Available online xxxx Keywords: Corporate political activity CEO discretion Firm performance Agency theory Stewardship Corporate governance

a b s t r a c t Corporate political activity (CPA) is an important nonmarket strategy aimed at advancing a firm's interests by influencing public policy. Yet studies report mixed results as to the impact of CPA on firm outcomes. Building on recent extant research we suggest that one reason for the ambivalent evidence regarding the impact of CPA on firm performance is the moderating role of CEO discretion on the CPA-firm performance relationship. In a longitudinal study of S&P 1000 firms over 10 years, we test competing perspectives regarding the moderating impact of CEO discretion on the CPA-corporate performance relationship. We find that some aspects of CEO discretion, in particular CEO duality, moderate the relationship between CPA and performance. The findings provide some support for an agency view of the impact of CEO discretion the CPA-performance relationships, which carry implications for both scholarship and regulation in the areas of CPA and corporate governance. © 2015 Elsevier Inc. All rights reserved.

1. Introduction Corporate political activity (CPA) constitutes firm initiatives designed to influence the public policy making process and its outcomes (Hillman & Hitt, 1999). While accurate as an overarching characterization of CPA, this definition leaves out the question of whose private ends will be advanced. The dominant view is that “management scholars emphasize strategic choice and assume that managers choose to engage in political activity to enhance the value of the firm” (Hillman, Keim, & Schuler, 2004, p. 839). Despite the explosion of research on CEO and top management team influence on firm strategy, little research has challenged this dominant view by exploring the role of top executives in determining the level and form of CPA. This is surprising, given the suggestion of Hart (2010, p. 179) and others that: “CEOs may also be quite autonomous in their political activities, […] in the corporate hierarchy, CEOs control so many resources that their subordinates are unlikely to object to such behavior”. In this context, we address in this article the following question: Does CEO discretion have a significant moderating influence on CPA outcomes? Our research question is important because research to date on the impact of CPA on firm performance is mixed and unsettled. A possible line of explanation for these mixed results is the unexplored internal dynamics of CEO discretion. As Li and Tang (2010, p. 48) pointed out, “when top executives have more discretion, their

impact on their firms are stronger”. More specifically, we contend that the difference between instances when CPA influences firm-level performance and when it does not may be whether a high-discretion CEO had a hand in the decision or not. In investigating this research question, we use and contrast agency versus stewardship perspectives to explore the moderating effect of CEO discretion on CPA outcomes (namely, financial and accounting performance). Our research question is important insofar as mainstream research and theorizing on CPA may have overlooked some CPA motivations other than maximizing shareholder interest. In the present article, we therefore explore an important linkage in understanding when CPA is effective and when it is less so. This exploration can inform theorizing on CPA as well as governance scholars and practitioners concerned with CEO discretion's impact. Our article is organized as follows. We first summarize the literature on CPA outcomes followed by a brief review of CEO involvement in firm's political activities. We then explore how CEO discretion might be put to use, either for the benefit of shareholders or for personal gain. Our hypothesis below converges these scholarship streams to explore the interactive impact of CPA and CEO discretion on firm performance. Lastly, after the methods section, we discuss new findings based on an empirical study of S&P 1000 firms for the years 1998–2008. 2. CPA, performance and CEO discretion 2.1. CPA and performance

⁎ Corresponding author. Tel.: +1 917 873 0052. E-mail addresses: [email protected] (M. Hadani), [email protected] (N.M. Dahan), [email protected] (J.P. Doh).

Scholars have examined the impact of CPA on various firm-level performance measures and reported positive and negative impacts, as well

http://dx.doi.org/10.1016/j.jbusres.2015.03.046 0148-2963/© 2015 Elsevier Inc. All rights reserved.

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

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M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

as no impact. On the positive side of the argument, some empirical studies show that CPA can result in obtaining government subsidies (Haley & Schuler, 2011), lowering effective tax rates (Richter, Samphantharak, & Timmons, 2008), attaining trade protections (Drope & Hansen, 2004), or receiving permission for rate increases by US electrical utilities (Bonardi, Holburn, & Vanden Bergh, 2006; see also Hillman, 2005). Other studies, however, concluded that CPA has a negative impact on firm outcomes (Aggarwal, Meschke, & Wang, in press; Coates, 2012) or no effect on policy outcomes (Ansolabehere, De Figueiredo, & Snyder, 2003). Hadani and Schuler (2013), for instance, reported evidence to suggest that CPA has a negative impact on market value. Yet another research stream shows no effect – positive or negative – of CPA on performance. For example, Ansolabehere, Snyder, and Ueda (2004) reported no obvious impact of campaign contributions on performance, consistent with Hersch, Netter, and Pope's (2008) findings that campaign contributions do not create any financial capital. Faccio (2006) reported that while politically connected firms were able to influence policies regarding financial bailouts, these same firms faced poorer operating performance. The results of these past empirical studies suggest that there may be missing contextual factors that influence or shape the degree to which CPA can generate performance benefits, and this mixed and unsettled literature is the starting point for our investigation of the potential role of the CEO in influencing the CPA-performance relationship. 2.2. CEO involvement in CPA CPA is a complex mix of a wide variety of discrete activities such as electoral campaign donations, lobbying, grassroots advocacy, petitioning, organizing media campaigns, participating in trade associations and other related activities. These various activities can be combined coherently to implement an overall strategy that matches the firm's resources and objectives with its given political environment (Hart, 2010; Hillman & Hitt, 1999). The notion that CEOs steer firm CPA is not new. Decades ago, Epstein (1969) proposed that CEOs initiate and drive corporate political activities: “Another reason for corporate involvement in politics is based as much on managerial personality and prerogative as on the requirements of Realpolitik” (Epstein, 1969, p. 129; see also Leone, 1977). This observation was later supported by Post and Griffin's (1997) work indicating the involvement of top executives in CPA. Blumentritt (2003), Hart (2004, p. 56), Hart (2010) and Ozer (2010) also confirmed CEO influence over CPA decisions. 2.3. CEO discretion: a conceptual overview In analyzing CEO authority, Hambrick argued, “if we want to understand why organizations do the things they do, or why they perform the way they do, we must consider the biases and dispositions of their most powerful actors — their top executives” (Crossland & Hambrick, 2007, p. 334). Hambrick and Finkelstein (1987) argued that discretion determines the potential impact leaders can have on organizations. Indeed, contexts in which CEOs have considerable discretion provide an opportunity for CEOs to more directly influence firm performance (Finkelstein & Boyd, 1998), for good or for bad. Thus, we focus on the concept of managerial discretion, what Hambrick and Abrahamson defined as “latitude of action” (Hambrick & Abrahamson, 1995, p. 1427); its obverse being constraint (Hambrick & Finkelstein, 1987, p. 374). Many empirical studies have confirmed that when top executives have more discretion, their influence on the firms they oversee is stronger (e.g., Crossland & Hambrick, 2007; Finkelstein & Boyd, 1998; Finkelstein & Hambrick, 1990; Mackey, 2008). However whether that impact is negative or positive remains unsettled. On the one hand, drawing on agency perspectives, most economics-based research views managerial discretion as a negative byproduct of flawed corporate governance, leading to serious damage

to shareholder value (Eisenhardt, 1989), as discretion allows CEOs to take advantage of firm actions and to leverage such actions to their own opportunist ends. On the other hand, the dominant view among management scholars assumes positive upside of managerial discretion (Finkelstein & Peteraf, 2007, p. 238). Indeed, managerial discretion may be necessary to allow executives enough latitude of actions to provide their firm the full measure of their individual value added (Cannella & Monroe, 1997). We explore these two views in the context of CPA below. 3. Agency and stewardship perspectives on CEO discretion and the CPA-performance link 3.1. CEO discretion and CPA outcomes: agency and stewardship perspectives Donaldson and Davis (1991) suggested that the question of whether CEO discretion has positive or negative impacts on performance outcomes is dependent on assumptions derived from stewardship theory versus agency theory. Applied to CPA, the impact of CEO managerial discretion over CPA on corporate performance can be similarly positioned, leading to two competing hypotheses. Given the mixed results of past empirical studies regarding the impact of CPA on firm performance, looking into the moderating effect of CEO discretion may uncover a link largely overlooked by scholarship so far. 3.2. CEO discretion and CPA outcomes: a stewardship driven perspective Management scholars have traditionally viewed CPA as a financially rational corporate strategy (Bonardi, Hillman, & Keim, 2005), generating firm-level benefits (Hillman & Hitt, 1999; Rehbein & Schuler, 1999). Some authors have found that the stock market expects political activity to benefit firms (Hillman, Zardkoohi, & Bierman, 1999; Roberts, 1990; Shaffer, Quesnay, & Grimm, 2000) and that in some industrial contexts CPA does improve corporate performance (Bonardi et al., 2005; Hillman, 2005; Hillman & Dalziel, 2003). In these situations, executives who decided to pursue CPA do so as stewards of their firm's shareholders. Consistent with this perspective, we argue that CPA influenced by high-discretion CEOs will benefit firm-level performance, for several reasons. CEOs are uniquely situated at the interface between the internal hierarchy and the external environment of their firms, allowing them to understand more intimately than most other employees and board members their firm's internal and external situations as well as interest. Their better grasp of their firm's internal standing is due to their holistic view of their organization, cutting across all functions and locations, a strategic position only possible from the very top, and developed with longer experience and power in that position (Luo, Kanuri, & Andrews, 2014). This unique position can be especially meaningful for CPA. For example, Hadani (2007) found that firms controlled by the founder's family, in which the firm founder is still involved, are more likely to be politically active. He suggested that their intimate knowledge of firm processes and capabilities enhances their personal influence on strategy making. In other words, the more knowledgeable top executives are about their firm, the better positioned they are to navigate its strategic landscape. Externally, CEOs may have access to exclusive information about the public policy environment through personal contacts and social capital (with journalists, public officials, other CEOs, heads of business associations, etc.) accrued by their positions' prestige, high visibility and many opportunities (often initiated by CEOs) for socializing with public policy makers (Hart, 2004, 2010; Reich, 2010). Therefore, their boundary spanning position may lead them to develop unique insights about public policy that are potentially beneficial to their firm, and which CEO discretion allows them to realize.

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

Moreover, the unique nature of CPA may necessitate higher CEO discretion. Specifically, in the political environment, unlike the financial or product environment, it is harder to isolate and detect causal linkages between public policy demanders and suppliers' political actions, partly because firms' do not influence public policy outcomes directly (Hillman & Hitt, 1999; Keim, 2001; Kersh, 2002; Smith, 2000). This uncertain strategic nature provides a fertile context for high discretion CEOs to leverage their internal knowledge and external connections and to assist the firm with navigating a less than certain landscape, adding value to merely donating money or hiring lobbyists. In other words, the strategic nature of CPA coupled with CEO discretion may lead to beneficial outcomes, which can be viewed as acts of corporate stewardship by CEOs on behalf of firm owners. This stewardship-based view has been dominant in CPA scholarship so far (Hillman et al., 1999; Hillman et al., 2004). Overall, this stewardship perspective views high-discretion CEO influence over CPA as beneficial to firm owners: discretionary CEOs ensure more efficient and impactful use of corporate resources towards political activities than any lower-level officer in their company would have been able to direct. Thus we propose: Hypothesis 1. CEO managerial discretion will moderate the relationship between CPA and firm performance such that CPA in the presence of higher levels of CEO managerial discretion will be positively associated with firm performance, whereas when CEO discretion is low, CPA will not impact firm performance.

3.3. CEO discretion's and CPA outcomes: an agency-driven perspective There are, however, alternative rationales for CEOs to use their managerial discretion to steer CPA towards outcomes that are not necessarily in the firm's interest. First, the agency theory view of CPA focuses on the personal benefits that accrue to CEOs of politically active firms and that may push them to engage in CPA regardless of its firm impact. Moral hazard operates in the background of CPA. Building on this view, greater CEO discretion better positions CEOs to maintain such benefits and also extract rents with limited interference. Empirically, several corporate governance scholars have found CEO managerial discretion to be associated with an increase in agency costs and the ability to deflect audit, diminish monitoring lessening the priority accorded shareholders' interests (Bebchuk & Fried, 2004; Golden & Zajac, 2001). This can happen when the CEO also serves on the board of directors and especially when she/he chairs it. This can work as an enabler of managerial discretion and can be abused in the form of self-serving behaviors and non-value maximizing strategies (Diamond, 1993; Frankforter, Berman, & Jones, 2000; Tuggle, Sirmon, Reutzel, & Bierman, 2010). This opportunistic behavior is mainly due to the opaque nature of CPA. Hadani and Schuler (2013: 176) observed that “CPA is difficult for shareholders to monitor […] firms are not required to report many political expenses in their annual financial reports. This creates information asymmetries between shareholders and managers, which have been associated with moral hazards and increased agency costs”. This can indeed occur regarding CPA, as Coates (2012), and Hadani (2012) found that institutional ownership (a marker of tighter governance and reduced discretion) is negatively associated with CPA. Several authors have noted that CPA may benefit executives rather than firms. For examples, CPA has been associated with increased executive pay (Arlen & Weiss, 1995; Gupta & Swenson, 2003), and increased stock option compensation at an inflated price (Yu & Yu, 2012). Others note that personal prestige or reputation may be associated with CPA (Faccio, 2006; Hart, 2004) and CPA may increase a CEO's social capital (Reich, 2010, pp. 105–106), which may be used for personal gains (Coates, 2012). Thus the combination of CPA-accruing personal benefits with increased discretion can harm shareholder value creation, as CEOs follow

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opportunistic motivations instead of firm level benefits. Further, even without this explicit agency rationale, a behavioral perspective on CEO actions could also result in perverse outcomes. Many CEOs lack experience, have limited expertise and understanding of the public policy process and may simply make the wrong call, a reflection of managerial “hubris” whereby a CEO's overconfidence and excessive pride drive her/him to suboptimal decisions (Hayward & Hambrick, 1997). These cognitive biases are often driven by inflated egos, and come in the form of CEOs who overestimate their problem-solving capabilities, underestimate the resource requirements of a course of actions, or misjudge the uncertainties related with a certain strategy (Li & Tang, 2010). Lastly, CEOs may be trapped in a sort of CPA “arms race”: CEOs steer their firms towards investing in CPA because they feel pressure to maintain at least competitive parity with rivals (Gray & Lowery, 1997; McKay & Yackee, 2007). This is similar to the phenomenon of escalating CEO salaries whereby firms are incentivized to bid for top talent and potentially overpay to secure the very best CEO. Because political resources are easily imitable (such as a political donations, hiring lobbyists, running ad campaigns) investments will not generate sustainable political advantage, as rival firms will quickly replicate these efforts, canceling any edge the first-moving firm would create for itself (Boddewyn & Brewer, 1994; Dahan, 2005). Taken together, these critical perspectives suggest that CPA guided by discretionary CEOs will yield poorer corporate performance than if the CEO had not meddled with the activity. In other words, the unique position of the CEO in a firm environment may lead to a valuedestroying influence over CPA decisions. Therefore we propose: Hypothesis 2. Alternate CEO managerial discretion will moderate the relationship between CPA and firm performance such that CPA in the presence of higher levels of CEO managerial discretion will be negatively associated with firm performance, whereas when CEO discretion is low, CPA will not impact firm performance.

4. Methods 4.1. Sample and data The data set includes S&P 1000 firms for the years 1998–2008. We focus on the S&P 1000 due to missing data on firm financials and compensation on the small cap and even many mid cap firms from the Compustat/Execucomp databases. We focus on the years 1998 to 2008 given data availability on political expenditures. To obtain firm political expenditure data, we used FEC records (www.fec.gov) and archival sources, such as the Center for Responsive Politics (www.crp.org) and the website of the Senate's Office of Public Records (www.senate.gov/ legislative/Public_Disclosure/LDA_reports.htm). Financial, compensation and board information were drawn from Compustat, Execucomp and the corporate library databases. Combining our different data sources resulted in missing data for some firms. Missing data was randomly distributed across our sample and across years. Our final sample captures 650 of the S&P 1000 firms, with 3600 firm year observations. The sample includes all industrial sectors represented in the S&P 1000 sample framework. 4.2. Variables and measures 4.2.1. Dependent variables: firm performance We measured firm performance using three complementary measures: a financial one and two accounting measures. These included market value (for example, Chen, Parsley, & Yang, 2014), firm gross profit margin (Mother, Smith, & Olney, 2011), and return on assets (ROA) (McNamara, Deephouse & Luce, 2003).

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

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M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

4.2.2. Independent variables 4.2.2.1. Corporate political activity. We aggregated two of the most commonly used and researched forms of CPA, namely, making contributions to the election campaign of a candidate through political action committees (PACs) and firms' lobbying expenditures (Aggarwal et al., in press; Ansolabehere et al., 2003; Schuler, Rehbein, & Cramer, 2002). 4.2.2.2. CEO discretion. Because direct measurement of discretion is difficult (Carpenter & Golden, 1997; Hambrick & Finkelstein, 1987), we relied on four indirect measures, as previous empirical studies of managerial discretion have done. First, we included CEO tenure as it reflects a CEO's increasing authority and ability to direct the firm based on her/his own views (Allgood & Farrell, 2000; Henderson, Miller, & Hambrick, 2006; Miller, 1991). Second, we included CEO duality — that is, CEOs serving on the board as the chairperson or as a board member, which represents a significant opportunity for the CEO to influence the board and thus undermine its monitoring role (Kalyta & Magnan, 2008; Wade, O'Reilly, & Pollock, 2006). Third, we included CEO longterm incentive plans (LTIP), which consists of non-salary incentives such as equity and bonuses; and fourth, we included CEOs' base salary, as two related proxies for the discretion of the chief executive and her/his influence over board decisions (Bebchuk & Fried, 2004; Bebchuk, Fried, & Walker, 2002; Torsi & Gomez-Mejia, 1989). To validate the use of these different measures we ran an exploratory factor analysis using the oblique rotation method and find that our various measures of CEO discretion loaded on one factor (all factor loadings exceed .40; they ranged from .405 to .701). 4.2.3. Control variables 4.2.3.1. Year dummies. We used year dummies to capture possible temporal effects. 4.2.3.2. Industry dummies. At the industry level, we include a two-digit SIC industry dummy code and to capture additional industry level pressures and we also add a dichotomous measure of industry regulation (Grier, Munger, & Roberts, 1994). 4.2.3.3. Firm size. At the firm level we included firm size, measured as the firm's logged number of employees. 4.2.3.4. Firm performance. We included lagged firms' performance based on their lagged market value or lagged profit margin, based on the dependent variable analyzed. The inclusion of a lagged measure of performance is critical as many studies in the area of CPA find that a major predictor of performance is lagged performance (for example, Bonardi et al., 2006). 4.2.3.5. Board size. Board size, measured as the number of directors, was also included. We added this variable given our focus on CEO discretion and the role the board may play in curbing it. It is also based on scholarship on the potential governance role of a larger board and its ability to impact performance (Goodstein, Gautam, & Boeker, 1994). 4.2.3.6. Board independence. We accounted for board independence, measured as the number of outside or independent directors. We added this variable given our focus on CEO discretion and the role the board may play in curbing it. 4.2.3.7. Governance index. We included the Gompers, Ishii, and Metrick's (2003) governance index, or so-called G index, which represents the level of shareholder rights protections in a firm, in which higher levels of the index indicate lower levels of shareholder protection. Following Aiken and West (1991), we standardized all our variables prior to the analyses. Further, all independent variables (including but not limited

to firm performance) were lagged one year relative to our dependent variable. 5. Data analysis and results 5.1. Analysis In order to deal with the fact that our sample was unbalanced, we used a longitudinal regression analysis utilizing mixed effects modeling with a random firm subject component, and fixed year and industry dummies. In order to address the potential of two-way causality between our CEO discretion and CPA variables, we used a two-stage regression approach in which we regressed lagged measures of discretion on present CPA, and used the residuals of that regression in our final models, hence the CPA measure we used side by side with the four measures of CEO discretion are less likely to co-determine each other. Lastly, due to possible endogeneity concerns, we lagged our independent and control variables relative to our dependent variables. For all hypotheses, we ran a two-step hierarchical regression analysis. In the first step, we included a control model with industry and firmlevel variables as well the effects of CPA and CEO discretion. The second step incorporated the moderating effects of CPA and CEO discretion (see Table 2 below). 5.2. Results In Table 1, we provide the means, standard deviations, and correlations of all variables in our sample. The average total CPA expenditure across election cycles is around $530,000, which includes expenses for all publicly available data across all sample firms. The average staff size of a firm in our sample is 32,000 employees. 75% of sample firms have a CEO that serves on the board. Table 2 includes the regression analysis for our two measures of firm performance. To run the regression analyses we created new interaction terms. We interacted the four measures of CEO discretion on the single CPA measure, creating four interaction terms – namely, CPA and tenure, CPA and duality, CPA and long-term-incentives, and CPA and salary – to assess the two competing hypotheses. The findings provide partial support for Hypothesis 2, as opposed to Hypothesis 1. The association of the four interaction terms with market value shows that the interaction terms of CPA and CEO duality, as well as of CPA and CEO salary, are negatively associated with market value; whereas the interaction terms of CPA and tenure, and of CPA and LTIP are not associated with market value (respectively, β = − 3.66, p b .001, β = .00, p N .05, β = − .02, p b .05, β = .00, p N .05, model 1; Table 2). Regarding gross profit margin, the interaction term of CPA and CEO duality is negatively associated with gross profit margin, but the other three interaction terms are not significantly associated with gross profit margin (respectively, β = −.01, p b .05, β = .00, p N .05, β = −.01, p N .05, β = .00, p N .05, model 2; Table 2). For return on assets (ROA), the interaction term of CPA and duality is negatively associated with ROA, but the other three interaction terms are not significantly associated with ROA (respectively, β = −.01, p N .05, β = −.02, p b .05, β = −.01, p N .05, β = − .01, p N .05, model 3; Table 2). It is important to note that the reduction in log likelihood of all three models from the control to the full models is substantial and significant, meaning that additional variance was explained. To further understand the significant interaction effects, we plotted the interaction of the regression variables and the main significant interactions for market value, gross profit margin, and ROA (see Figs. 1 to 4). As depicted in Fig. 1, CEO duality moderates the impact of CPA on market value for high levels of CPA. However for firms engaged in lower levels of CPA, duality has a weak or negligible impact on market value. This figure shows a negative interaction of CPA and duality, providing support for Hypothesis 2. Fig. 2 depicts the interaction of salary

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

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Table 1 Means, standard deviations and correlation (1998–2008) cross sectional. Variables

Mean

SD

1. Firm performance (market value)a 2. Firm performance (GPM) 3. Firm performance (ROA) 4. Total political expenditures (CPA) 5. PAC contributions 6. Lobbying expenditures 7. Firm size (log of thousands of employees which is in parenthesis) 8. Board size 9. Board independence 10. Governance index 11. CEO tenure 12. CEO duality 13. CEO base salaryb 14. CEO long term compensationb

9360 .34 .05 528,185 59,479 473,728 4.5 (32)

27,564 1.54 .10 2,236,826 280,566 2,179,813 1.52

1 .11 .10 .45 .32 .54 .36

1 .06 .06 .02 .03 .11

4.04 .11 2.48 8.7 .31 664 2782

.23 .06 −.10 −.03 .09 .25 .21

.02 .02 .05 .01 .08 .01 −.01

11.70 .79 9.65 7.5 .75 935 518

1

2

3

4

5

6

7

8

9

10

11

12

13

14

1 .03 .01 .03 .07 .04 .02 .06 .00 −.02 .07 .04

1 .55 .95 .38

1 .40 .26

1 .23

.16 .07 −.06 .01 .08 .19 .17

.14 .05 −.02 −.01 .07 .08 .10

.15 .05 −.05 .02 .07 .19 .16

1 .26 .10 −.05 .00 .11 .46 .10

1 .11 .12 −.08 .06 .11 .05

1 .18 −.05 .09 .08 .06

1 −.06 .04 .05 .02

1 .09 .43 .08

1 .12 .08

1 .25

1

N varies between 4000 and 2800. a In ten thousands. b In thousands. Correlations greater than .04 are significant at a p b .05 level, greater than .06 significant at p b .01, greater than .08 significant at a p b .001, and greater than .10 significant at p b .00001.

and CPA on market value, showing that lower salary (as a proxy for lower discretion) increases the association of higher levels of CPA spending with market value, but less so for lower levels of CPA. Thus, higher salary barely moderates the impact of CPA on market value. This pattern shows that low discretion matters more than high discretion, a pattern only partially supporting Hypothesis 2. Fig. 3 shows that for gross profit margin, CEO duality matters more for higher levels of CPA spending. The absence of duality seems to have a similar effect on either level of CPA engagement. This pattern fully supports Hypothesis 2. Fig. 4 shows that regarding ROA, CEO duality reduces the association of higher levels of CPA and ROA, but does not have the same effect on low levels of CPA, again providing support for Hypothesis 2. Taken together these figures provide partial support for the moderating impact of CEO discretion on CPA outcomes.

Regarding our control variables, we find that lagged performance has the strongest effect on present performance and that CPA in and of itself is not significantly associated with market value, gross profit margin or ROA in all control of the full models. 6. Discussion and conclusion Taken together, our findings indicate that CEO discretion can indeed moderate the impact of CPA on firm performance, but that this effect will vary depending both on how we measure performance, and to some extent, on the proxies used to assess CEO discretion. Overall, our findings question the strategic leadership/ stewardship view regarding the positive impact of corporate leaders and their managerial discretion (Cannella & Monroe, 1997). The fact

Table 2 Regression analysis — dependent variables: firm performance. Dependent variables Control variables Year (dummies) Industry (dummies) Size (log number employees) Past performance (market value or GPM or ROA) Board independence Board size Governance index CPA CEO tenure CEO duality CEO long term incentives (LTIP) CEO base salary Main effects model log likelihood Interaction terms CPA ∗ tenure CPA ∗ duality CPA ∗ LTIP CPA ∗ salary Log likelihood Change in log likelihood

Control: firm market value

Model 1: firm market value

Control: gross profit margin

Model 2: gross profit margin

Control: return on assets

Model 3: return on assets

Included Included 4.5⁎⁎⁎⁎ (.49) .78⁎⁎⁎⁎ (.021)

Included Included 12.01⁎⁎⁎⁎ (.45) .42⁎⁎⁎⁎(.019)

Included Included −.01 (.000) .14⁎⁎⁎ (.016)

Included Included .00 (.000) .07⁎⁎⁎(.02)

Included Included .68 (.000) .16⁎⁎⁎⁎ (.025)

Included Included .07 (.000) .30⁎⁎⁎⁎(.03)

2.1 (.02) .98 (.003) −.08⁎⁎ (.09) .02 (.01) −.97 (.000) .75 (.029) 8.31⁎⁎⁎⁎ (4.01) 3.85⁎⁎⁎⁎ (2.5) 32,137⁎⁎⁎⁎

−.01 (.05) 3.1⁎ (.09) .07 (.01) −.01 (.01) −.05⁎(.02) −.33 (.01) 10.01⁎⁎⁎⁎(1.2) 10.2⁎⁎⁎⁎(1.5) –

.03 (.002) .03 (.003) .04⁎ (.002) .001 (.000) .010† (.009) .02† (.006) −.19 (.003) .01 (.001) −4010⁎⁎⁎⁎

.00 (.001) .001 (.003) −05⁎⁎(.001) .001 (.000) .01 (.003) .03⁎(.005) −.01 (.001) .00 (.001) –

.00 (.003) .00 (.005) .001⁎ (.004) −.01 (.012) .001⁎ (.004) .00 (.004) .00 (.001) −.01⁎⁎⁎ (.003) −1975⁎⁎⁎⁎

−.01 (.005) .00 (.004) .000 (.001) −.01 (.001) .001⁎ (.005) .01 (.004) .001 (.002) −.01⁎⁎⁎(.03) –

.00 (.001) −3.66⁎⁎⁎ (.001) .00 (.000) −.02⁎ (.000) 31,545⁎⁎⁎⁎ 592⁎⁎⁎

.00 (.001) −.01⁎ (.005) .00 (.001) −.01 (.000) −2938⁎⁎⁎⁎ 1072⁎⁎⁎

−.01 (.012) −.02⁎ (.015) −.01 (.002) −.01 (.004) −1709⁎⁎⁎⁎ 266⁎⁎⁎

N = 3600. † p b .10. ⁎ p b .05. ⁎⁎ p b .01. ⁎⁎⁎ p b .001. ⁎⁎⁎⁎ p b .0001.

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

6

M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

10000

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Fig. 1. The interaction of duality and CPA on mean market value (in ten thousands of dollars).

that none of our four interaction terms had a statistically significant positive association with firm performance provides a counterfactual to any assumption that the CEO involvement in CPA has a positive impact on performance. 6.1. Discussion and contributions Our overall findings, especially the consistently significant moderating influence of CEO duality on CPA outcomes reflects a core dynamic of CEO discretion as it contributes to “board capture”: a complacent and passive board that leaves free reigns to the CEO (O'Connor, Priem, Coombs & Gilley, 2006; Tuggle et al., 2010). In addition, our study generated a unique pattern of results regarding CEO compensation, showing that it is actually lower discretion that can benefit politically active firms. This finding is interesting and even though not originally predicted, can be viewed as providing indirect support for the critical views of CEO discretion. In other words, it is possible that less discretion (in terms of compensation) may actually help politically active firms improve their performance. Regarding the negative market reaction (market value) in the presence of discretionary CPA, we could venture two possible explanations. One is the agency explanation proposed earlier, in which CPA offers lucrative personal incentives (Coates, 2012; Sobel & Graefe-Anderson, 2014) with unclear firm level benefits. A second agency explanation is that high CEO discretion over CPA is a market signal of weaker corporate governance overall, leading to abnormal (excessively high or low) risk taken and unchecked decisions by high-discretion CEOs, as alluded to recently (Coates, 2012; Igan, Mishra, & Tressel, 2009). Given this signal,

High CPA

Fig. 3. The interaction of duality and CPA on mean gross profit margin.

the markets (i.e., investors) anticipate firm performance deterioration. Our study therefore provides qualified support for the view that CEOs enjoying high managerial discretion may be able to pursue CPA independent of their firm's interest. This opportunity is compounded by the very limited accountability required by the board, as CPA is legally considered to fall under “ordinary” business decisions, and few firm shareholders have managed to pass a resolution requiring explicit reporting of CPA to their board (Bebchuk & Jackson, 2010; Coates, 2012: 662). It must be noted that we cannot say with absolute certainty which one(s) of the explanations we ventured for discretionary CPA (in the hypothesis section) leading to negative corporate performance is/are correct. Although we ventured multiple mechanisms through which CEO discretion can negatively moderate the relationship between CPA and firm performance, it seems less likely that the origin is managerial incompetence given that longer tenure should lead to higher executive competency (Finkelstein & Hambrick, 1990). One potential methodological explanation as to why we find that only duality was a significant moderator with regard to the accounting measures of gross profit margin and ROA can be inferred from Mackey's (2008) research on CEO discretion and firm performance. She found a stronger association between CEO discretion and corporate level measures of firm performance (such as market value) in comparison to the association of CEO discretion to aggregate segment level measures of performance. We used three measures of performance, one is the market value of the firm as a whole as assessed by the market (investors) and the other two, gross profit margin and ROA, like other accounting measures, reflect cumulative cash or income accruing from different firm segments. Thus they may be less sensitive to CEO discretion, as would other accounting measures be.

12000 0.06

11000 10000

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8000 Higher Salary 7000

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0 Low CPA

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Fig. 2. The interaction of base salary and CPA on mean market value (in ten thousands).

Low CPA

High CPA

Fig. 4. The interaction of duality and CPA on mean return on assets (ROA).

Please cite this article as: Hadani, M., et al., The CEO as chief political officer: Managerial discretion and corporate political activity, Journal of Business Research (2015), http://dx.doi.org/10.1016/j.jbusres.2015.03.046

M. Hadani et al. / Journal of Business Research xxx (2015) xxx–xxx

Overall, our findings add to our understanding of the complexity of CPA and should inform its theorizing. While some may argue that CPA is a strategically beneficial activity, recent scholarship has questioned both the rationale for and the consequences of CPA (Aggarwal et al., in press; Ansolabehere et al., 2003, 2004). By introducing a non-value maximizing rationale we can understand why and when CPA is detrimental. Interestingly we find that CPA itself is neither positively or negatively associated with firm performance. Thus, it is the combination of the strategic context of CPA and managerial discretion that can prove somewhat detrimental to firm outcomes. In other words, some aspects of CEO discretion are indeed a moderator of the relationship between CPA and corporate performance. 6.2. Implications for policy and practice Our findings add to the long list of CEO discretion's effects over the firm's shareholder value. CEO influence can result in corporate overinvestment in CPA, leading to deteriorating corporate performance, sometimes for the personal benefit of the CEO. These benefits can include increased compensation (without performance pressures), developing the CEO's prestige and reputation (Reich, 2010), personal social capital (Faccio, 2006; Hart, 2004), preparing a post-corporate career in politics (Coates, 2012), and possibly pursuing an ideologically partisan agenda (Nalick, Kuban, Schijven, & Xu, 2014). Unfortunately such a tendency can actually harm firm performance. Our findings have therefore important implications for shareholders and their board, as well as public policy-makers. Specifically, those responsible for the oversight and direction of executive leadership – shareholders as represented by the board of directors – should not take at face value any argument made by executives regarding corporate political engagement in general, and any public policy option they advocate in particular. Indeed, the recommended option may not necessarily benefit the firm's shareholders, especially if the CEO is also Chair of the Board. Instead, it may only satisfy the CEO's personal agenda or misguided judgment. This conclusion is timely in light of the US Supreme Court's 2010 Citizens United decision, which relaxed the ability of corporations to make electoral contributions. The Supreme Court felt that the existing restrictions were unwarranted given that shareholders could adequately oversee their firms' spending. We provide support to the dissenting minority view among the justices that strongly challenged this assumption. 6.3. Limitations and avenues for future research Our study has at least two sets of limitations. First, we mostly focused on the financial aspects of firms' CPA, based on publicly available financial expenditure data. We realize that we did not measure less salient or less visible corporate political activities. These additional aspects could include depositions before Congressional bodies or informal meetings (such as behind-the-scenes interactions with officials and journalists) not privy to the public. Future research should include additional proxies of CEO discretion, such as the CEO's social prestige, professional background or stock ownership (Finkelstein, 1992). Future research could also explore how discretion translates into specific ideological choices in CPA and beyond. In addition, it would be particularly interesting to explore the relative influence of the top executive directly in charge of political activities (such as a Senior Vice-President for Public Affairs and Governmental Relations) relative to the CEO. To summarize, this study is one of the first to find a negative relationship between CPA, CEO discretion and various aspects of firm performance. This novel finding can help explain why firms pursue a strategy that is uncertain yet popular, and why firms may continually allocate financial resources to establish and maintain relationships with public policy makers.

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