The New York Times

August 26, 2004

Donations Can Buy You Profits


WALL STREET analysts follow presidential campaigns, and for good reason. The future revenues of pharmaceutical companies, energy companies, military contractors and other industries depend in part on which party is in power.

Every presidential election year, analysts publish lists of stocks they think will increase in value if one party or the other wins.

As the fortunes of the candidates ebb and flow, the stocks of such politically sensitive companies should respond in a predictable way: industries that are expected to do well if President Bush wins should increase in value when his likelihood of winning goes up, and industries that would probably prosper under John Kerry should increase when sentiment swings in his favor.

This platform capitalization theory was recently examined by the Brown University economist Brian G. Knight in a National Bureau of Economic Research working paper, "Are Policy Platforms Capitalized Into Equity Prices?"

Mr. Knight examined the 2000 presidential race using financial analysts' reports that identified companies likely to do well under an administration headed by George W. Bush or one headed by Al Gore. There were 41 companies on the Bush list and 29 on the Gore list.

Analysts expected that pharmaceuticals, defense, traditional energy and tobacco would do better under Mr. Bush. Alternative energy and Microsoft competitors were expected to do better under Mr. Gore. The 70 companies in Mr. Knight's sample represented about $3 trillion in stock market value, or about a fifth of the total value in the Wilshire 5000.

Mr. Knight calculated the daily excess returns on each of the 70 stocks over the course of the campaign. (Excess return is the actual return adjusted for the overall movements of the market on a given day.)

As a proxy for the fluctuating probability of winning, Mr. Knight drew on data from the Iowa Electronic Markets. The online markets, accessible at, offer participants a chance to bet on the outcome of the election.

One security they offered paid $1 if Mr. Bush received more popular votes than Mr. Gore, and nothing otherwise. Because the security could be bought or sold at any time, its current market value represented, in some sense, the market's expectations for a Bush victory.

The platform capitalization theory presumed that the day-to-day changes in Mr. Bush's and Mr. Gore's chance of winning would be reflected in the stock market value of the companies expected to prosper under the two administrations.

Indeed, that was exactly what Mr. Knight found. According to his estimates, Gore-favored companies were worth 6 percent less in a Bush administration, while Bush-favored companies were worth 3 percent more, adding up to a 9 percent difference. According to Mr. Knight, "Bush's victory over Gore transferred over $100 billion in market capitalization from the 29 Gore-favored firms to the 41 Bush-favored firms."

Looking at particular sectors, Mr. Knight found that alternative energy companies were worth 16 percent less under Mr. Bush, while tobacco companies were worth 13 percent more.

Given the amount of money potentially at stake in election outcomes, it is not surprising that companies choose to contribute to campaigns. Such contributions could be an attempt to influence election outcomes, or they could be an effort to influence campaign platforms.

Either way, one would expect contributions to be correlated with expected value: companies that expected to do well if Mr. Gore was elected would be expected to contribute more to the Democrats, and those that expected to do well if Mr. Bush was elected would probably contribute more to Republicans.

So the amount of contributions to a party should reflect, to some degree, the anticipated value of that party ending up in power. Indeed, Mr. Knight found that the contributions were correlated with the stock market returns as the theory predicted: the companies that were expected to do well under Mr. Bush contributed more, proportionally, to the Republican Party than to the Democratic Party.

Finally, Mr. Knight looked at the Florida recount. During this six-week period, the election outcome was uncertain. Comparing returns over this period, he found that the return on Bush-favored companies exceeded the return on Gore-favored concerns by about 4 percent - a difference, the author notes, that is statistically insignificant. It is possible that stock prices already reflected the likelihood of a Bush victory, and thus did not respond strongly to the outcome of the recount.

But enough of the past. What about the current race?

An unscientific search of the Web suggests that several of the same industries that played a role in Mr. Knight's study are also relevant in the 2004 election: tobacco, pharmaceuticals, defense and energy. The expected impact on the sectors of a Democratic victory in 2004 seems to be about the same as it was in 2000. But the Microsoft antitrust case was prominent in the news in 2000; technology stocks do not seem to be quite as important this time around.

The Iowa markets are offering Bush and Kerry securities this year, and the current odds are about even. Other online futures markets, like, offer similar assessments. Mr. Knight is following the stock market and the campaign closely, but so far has not found much variation in the election forecasts from the online markets, making it difficult to relate changes in election probabilities to stock values.

Perhaps it is unpleasant to some to be reminded of how important a role money plays in politics. Yet how could it be otherwise? With billions of dollars in the balance, people will try to find ways to protect or enhance their assets. Over all, being able to hedge political risk on the stock market has to be a good thing. From a shareholder's viewpoint, political risk is like any other risk that might affect portfolio values, and being able to lay off some of that risk in the market is advantageous.

Corporate spending to influence platforms or outcomes is another matter. That it will happen is inevitable; the challenge is to keep it under control. In politics, money may talk, but it shouldn't shout.

Hal R. Varian is a professor of business, economics and information management at the University of California, Berkeley.

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