Sovereign Wealth Funds: Playing Politics?
- After the 2010 U.S. Supreme Court decision that opened campaign finance to corporations, sovereign wealth funds were more likely to invest in politically active U.S. firms than before. The effect was particularly pronounced among politically-active firms in strategically sensitive industries. For them, the probability of receiving foreign sovereign investment rose by 23 percentage points.
- Firms’ campaign finance contributions increased after investment by sovereign wealth funds. On average, political contributions increased by almost threefold for firms receiving sovereign wealth fund investment than for a group of control firms.
While the jury is out regarding the extent of Russian meddling in the 2016 U.S. election, it’s clear that sophisticated hacking schemes are not the only ways foreign countries can try to make a mark on American politics.
Campaign finance may be another channel. After all, the campaign finance landscape was dramatically reshaped in 2010 with the U.S. Supreme Court ruling in Citizens United vs. Federal Election Commission. Just weeks after that ruling, then President Barrack Obama warned in his State of the Union address that it would “open the floodgates for special interests, including foreign corporations, to spend without limit in our elections. I don't think American elections should be bankrolled by America's most powerful interests, or worse, by foreign entities.”
It appears those concerns were justified. Sovereign wealth funds provide an intriguing case in point; as a new study shows, some of these flush state-controlled funds take equity positions in U.S. firms identified as big campaign contributors, seeing such investments as political insurance policies. As Paul Calluzzo, one of the study’s researchers, says, “We provide some of the first evidence consistent with political motives for sovereign wealth fund investment in the United States.”
This result may surprise those analysts who view sovereign wealth funds as passive investors. Most of these funds, made up of revenue from commodity exports, are particularly favoured by oil-exporting nations. They are seen as a way of mitigating the volatility of resource prices and unpredictability of resource extraction.
Changing Motives for Foreign Sovereigns
The prevailing view of sovereign wealth funds is that they invest like mutual funds, seeking out large, highly liquid firms in which they can purchase relatively small, passive stakes and remain anonymous.
But recent research paints a somewhat different picture. Studies suggest that sovereign wealth funds invest in countries in which the fund’s state sponsor has weak or deteriorating political relations and that investments can be tied to political goals when political leaders have direct involvement in the fund’s day-to-day management.
To build on this research stream, Calluzzo, of Smith School of Business, with G. Nathan Dong of Columbia University and David Godsell of University of Illinois at Urbana-Champaign, turned their attention to the U.S. political environment, which looked like an ideal setting.
That’s because Citizens United, combined with the SpeechNow vs. FEC ruling the same year, dramatically liberalized corporate campaign finance activity. The researchers figured that this would give sovereign funds the opportunity to invest in U.S.-listed politically active firms and thereby circumvent the federal ban on foreign political contributions.
Sovereign states, especially those desiring access to the world’s largest economy, face increased political barriers to investment and have a clear incentive to gain a voice in the U.S. political process
If that would be the means, what would be the motivation? The researchers suspected that sovereign wealth funds would take equity positions in not just any politically active firm but those situated in key industries. While the U.S. has a long history of inhibiting foreign investment, barriers became much more imposing after the enactment in 2008 of the Foreign Investment and National Security Act. As a result, the Committee on Foreign Investment in the United States (CFIUS), which vets foreign investment, increased its scrutiny of strategically sensitive industries such as steel works, aircraft manufacturing, defense, and precious metals. Approvals were difficult to secure, post-merger monitoring and enforcement were tightened, and penalties made more severe.
Given that politically active firms have been shown to be more insulated from political backlash and less susceptible to regulatory oversight and enforcement, the researchers figured they would be attractive vehicles for sovereign wealth funds.
“Sovereign states, especially those desiring access to the world’s largest economy, face increased political barriers to investment and increased political uncertainty for existing and future investments and have a clear incentive to gain a voice in the U.S. political process,” the researchers state in the Journal of International Business Studies.
For their study, the researchers collected campaign finance data from the FEC and examined the funds’ investment in these firms using data from the Sovereign Wealth Fund Institute, covering the 2005 to 2014 period. The funds were from Canada, China, Korea, Kuwait, Norway, Qatar, Singapore, and United Arab Emirates.
Political Activity is Attractive
When they examined the investment behaviour of the sovereign wealth funds before and after the Citizens United decision in 2010, they noticed a change in which U.S. firms the funds chose to target.
After 2010, the sovereign wealth funds were indeed more likely to invest in politically active firms than before 2010. The effect was particularly pronounced among politically-active firms in industries under CFIUS purview. For them, the probability of receiving foreign sovereign investment rose by 23 percentage points from pre- to post-Citizens United.
“How important is this factor?” asks Calluzzo. “We identified nine firm characteristics that sovereign wealth funds care about and found that this was basically as big a determinant for their investment as anything else that the funds were looking at.”
Their study also revealed that the firms’ campaign finance contributions increased after investment by sovereign wealth funds. On average, political contributions increased almost threefold for firms receiving sovereign wealth fund investment than for a group of control firms.
The study should give both regulators and shareholders food for thought. For regulators, the results seem to provide evidence for how a channel of political influence — beyond lobbying — can potentially undermine the effectiveness of foreign investment review. And they could justify even closer CFIUS scrutiny of foreign government investments via sovereign wealth funds.
For shareholders, sharing equity ownership with a sovereign wealth fund may make them wonder if they all have the same interests at heart. “To the extent that foreign sovereigns use firms as a conduit for nonfinancial motives,” the researchers say, “principal–principal conflicts, akin to the principal–principal conflicts between long- and short-horizon investors, may exist.”
— Alan Morantz
Funding for the study’s data panel was provided by the CPA Centre for Governance at Smith School of Business.