Public pension plans rely on the help of investment advisory firms, but do politics play a role in which firms they choose to work with?

A paper co-written by William Beggs, an assistant professor of finance at the University of San Diego School of Business and Thuong Harvison, a PhD candidate at the University of Arizona’s Eller College of Management, suggested there is a history of links between firms’ donations to politicians and whether they end up working on relevant public pension funds.

“Recent literature has documented that firms, in general, enjoy benefits when they initiate relationships with politicians,” the paper said. “These relationships can be built through political contributions during election campaigns. Managers of firms may make political contributions strategically to gain favourable treatment from politicians. Our study broadly examines whether there is evidence of this type of quid pro quo activity in the investment management industry.”

The simple test for this theory involved finding out whether an investment or consultancy firm obtains a greater fraction of their business from government clients if their owners and officers have recently donated to politicians, focusing on state-level elections.

Indeed, the research found that there is a significant positive correlation between donations and increased government-based business. It found that advisors who donate see 0.5 percentage points more government clients among their client bases. While the percentage may seem small, it equates to 390 more government accounts on average per advisor. The paper noted that given the typically large asset-size government clients, there is substantial economic benefit to be gained by this correlation.

In seeking to further demonstrate the validity of the correlation, the paper looked to a 2011 rule adopted by the U.S. Securities and Exchange Commission. To address the problem of managers and consultants using donations to influence politicians to hire them on public pension accounts, the SEC implemented an anti-fraud rule to deter this so-called pay-to-play behaviour. “Specifically, the rule makes it illegal for an investment advisor to provide advisory services to a government entity for two years after the advisor or any of its officers, owners, employees or associates contribute to elected officials or candidates who hold influence over the plan or selection of plan trustees,” the paper noted.

This ruling acted as a shock to the system, deterring this pay to play behaviour, it said.

“Consistent with the hypothesis that the presence of public clients for investment advisory firms is affected by officers’ political contributions, we find the prevalence of pay to play activities declines after the adoption of SEC’s rule,” the paper said. “We also observe a sharp drop in the percentage of advisors with a significant presence of government clients making political contributions post rule enactment, consistent with the notion that donations play a role in securing public clients.”

The paper’s results were the most pronounced for advisors offering pension consulting services, serving to institutional accounts and headquartered in states with a high concentration of public pension plans and a culture of political corruption.