Political Representation and Governance: Evidence from the Investment Decisions of Public Pension Funds
How do politicians affect the governance of the organizations with whom they are associated as board members or fiduciaries? A number of studies in the economics and finance literature suggest that political connections can be extremely valuable for firms, leading to higher firm value. A less explored aspect of political connections, however, is how the political and personal incentives of politicians may affect the governance of the public organizations with which they are associated. In this paper, we explore the effect of political representatives on the decisions and performance of the public organizations on whose boards they serve. We identify a new channel through which political influence can affect outcomes, namely asset management. On the one hand, politicians with influence over asset management might be able to use their influence or expertise to gain access to and direct assets into higher performing investments. Alternatively, conflicts of interest or a lack of financial expertise might lead them to pursue political goals in their trustee capacity, at the cost of the financial returns of the investments.
We find that the performance of public pension funds’ private equity investments is strongly related to the relative representation of political representatives on the public pension funds’ boards. Specifically, each additional ten percentage points of the board who are government officials reduces performance by 0.9 net IRR percentage points if the official is appointed by another government official, and by 0.5 net IRR points if the official sits on the board by virtue of her office (ex officio). We find support for two potential channels that explain the underperformance by boards of trustees that are heavily populated by politicians. First, we document three failures that explain approximately half of the underperformance of pension funds with boards heavy in state-appointed and state-exofficio members. First, such pension funds invest more in real estate and funds of funds, which are categories that have delivered lower returns. Second, these board members overweight local in-state investments in real estate and VC, which negatively affects performance. Third, poorly governed pension funds are more likely to invest in small funds with few other investors and managed by inexperienced GP. These results lend support to a Control channel, whereby political representatives direct investment into PE funds that may be perceived as supportive of state economic development but that are not part of a financial strategy of maximizing expected return subject to a given level of risk, or minimizing risk subject to a given level of expected return. Second, part of the underperformance by state officials can be explained by controlling for the political contributions received from the finance industry relative to the pension fund assets under management. We document that pension funds governed by board members who have received relatively more contributions from the finance industry obtain lower returns. To the extent to that politicians derive personal gain from political contributions, these findings support a Corruption channel. When we exploit the extent to which the results are driven by varying financial expertise and experience across the types of board members, we find that prior financial experience is valuable and is associated with selection of private equity funds that deliver higher performance. The lower financial expertise of elected plan members explains most or all of their underperformance, but it does not explain the poor performance of state appointed and ex officio members. Political board members on average score moderately well on financial expertise but display the largest underperformance of the groups in the sample. Confusion is therefore unlikely to be the force driving the underperformance of pension funds whose boards have higher representation of state officials, although it does explain the
underperformance of boards with a large share of elected plan members.
Our results about the impact of politicians on public asset management boards contrast with the literature that studies the effects of politicians on corporate boards. The corporate literature finds that when politicians serve on boards, they bring benefits to the shareholders of the firms, either through enhanced access to procurement contracts or a lower cost of capital, thereby aiding the board in its primary objective of creating shareholder value. In the public pension investing context, the presence of politicians on boards appears to work against pension funds’ primary objective of delivering the benefits promised to the participants as efficiently as possible for taxpayers. In other ways, however, the results can be viewed as consistent. Indeed, both the benefits to firms with political board representation and the costs to public pension systems with political board representation may be paid for to a large extent by taxpayers.