In 2021, US legislators traded $355 million worth of stocks. Nearly 100 lawmakers across the political aisle even reported that they or their family members made trades on companies, which their committee work influences. It seems making money is a bipartisan issue.
Calling for an end to lawmaker trading is also a bipartisan activity. Diametrically opposed political personas such as Tucker Carlson and Rep. Ilhan Omar both advocated for an end to the practice after reports that Sens. Richard Burr and Kelly Loeffler made moves that shielded their wealth from the initial impact of the coronavirus pandemic.
The failure of the TRUST in Congress act, which would have barred both lawmakers and their family members from directly investing in companies, suggests there’s little consensus on how to handle these perceived ethical breaches. On the flip side, savvy investors can also put money into exchange-traded funds (ETFs) that are pegged to either Republican or Democrat stock purchases and sales. These ETFs point to an intriguing relationship between private investors and their perceptions of lawmakers’ insider knowledge.
The University of Arkansas’s professor of strategic management Jason Ridge and doctoral candidate Roary Snider tested this firm-government interface in their recent article, “Perceptions of political Self-Dealing? An empirical investigation of market returns surrounding the disclosure of politician stock purchases.” With fellow researchers Mirzokhidjon Abdurakhmonov and Dinesh Hasija, they found that when lawmakers disclosed their purchases, those stocks tended to see abnormal returns. This relationship was strengthened when the lawmaker had direct jurisdiction over the firm’s industry based on their committee work.
Interestingly, the researchers also found further support for earlier observations that lawmakers do not outperform the market as a rule. Both their stock sales and purchases experienced abnormal losses on longer time horizons. On the one hand, Ridge, Snider, Abdurakhmonov, and Hasija’s work suggests that firms may indeed want to court lawmaker investors since they can expect some positive returns due to public perceptions about the insider knowledge of legislators. On the other hand, their work also cautions private investors from blindly following lawmakers’ stock options.
STOCK Options
In 2012, Congress passed the STOCK act, which mandates lawmakers disclose changes to their and their family’s stock positions within 45 days of the transaction. Fines for noncompliance are minimal, but lawmakers have largely obliged to follow the act’s stipulations, although there is also plenty of bipartisan violations of the act. This data gives us a pretty clear look into the stock purchases and sales that lawmakers make every year.
Using this data, Ridge, Snider, Abdurakhmonov, and Hasija measured the response private investors had when lawmakers publicly disclosed their stock purchases. The researchers examined the US Senate Financial Disclosure website and hand sorted through the reports from 2012 to 2020 to ensure they had return data for the firms that lawmakers purchased stock in. They also excluded from their data set any reports that included both a purchase and a sale for the same firm, since the market impact would presumably be canceled out.
Senator stock purchases saw statistically significant abnormal returns, between 0.09% and 0.11%. For reference, at many of the firms in their sample, a return of 0.14% would be equivalent to about $150 million. Furthermore, these purchases were made on days after a streak of negative or statistically insignificant returns, so the disclosure of a senator’s stock purchase was enough to change the overall trajectory of a stock from negative to positive!
The market especially responds to stock purchases by senators with jurisdiction over the firm. When the disclosing senator does not have jurisdiction over the firm they’re investing in, the researchers saw returns close to 0%. When the senators did have a relevant committee appointment, there was instead nearly a 0.5% return. If a firm was lobbying the senator, the market rewarded that firm with a further 8% increase, and firms could also push the positive relation by contributing to the senator’s campaign. For a 10% increase in campaign contributions, the researchers saw a 2% higher abnormal return.
In their analysis, Ridge, Snider, and the other researchers noticed that senators seemed to generally “buy the dip.” That is, senators seem to purchase stocks after they’ve been experiencing a run of negative returns. They also tended to sell stock when it is returning abnormally negatively as well. In either case, the stocks that senators sold and purchased both experienced negative abnormal returns, although their sales had larger abnormal negative returns.
The researchers found that the market does not seem to respond to whether the senator is a member of the majority or not, but it does reward firms that are within the senator’s geographic purview. The researchers infer that this means the market is looking for potential insider information, not policy direction.
Senate Investiture
Based on these findings, Ridge, Snider, Abdurakhmonov, and Hasija suggest firms should strategically expand their relationships with senators. In a sense, doing so allows firms to double dip. They are both partially shielded from any risks coming from the government, and they can expect a nice return on their stocks if (and when) a senator invests in their company.
On the other hand, the researchers point out that lawmakers do not regularly beat the market, even though they are perceived as having some kind of insider knowledge. Chasing senatorial investments may not be a winning strategy in the long-term. Even though evidence suggests both senators’ stock purchases and sales tend to experience abnormal negative returns, the market seems to expect senators to use privileged knowledge to ensure large returns. If anything, this government-firm interface highlights the distrust people have for politicians to behave ethically.
Ridge, Snider, Abdurakhmonov, and Hasija suggest it may be wise to limit lawmakers’ portfolios to blind trusts and ETFs, so their active trading isn’t misinterpreted. These kinds of stock holdings would follow the broader trends of the market, and much like the theory on CEO compensation in stock options, it would peg congressmembers’ returns to their job performance, insofar as their jobs are measured by the strength of the economy.
