Asset Allocation and…Political Misconduct?

Topic: Pearls of Wisdom

Alexandra Jemetz CIM

March 24, 2016

Image used with permission: iStock/kates_illustrations


Print & Share

Print

Asset Allocation and…Political Misconduct?

Seeing the words ‘politician’ and ‘misconduct’ occasionally in the same sentence should be surprising to no one. But predicting a politician’s propensity to engage in misconduct by examining his (or her) investment portfolio’s asset allocation?

Harvard Business School’s Visiting Assistant Professor Dylan Minor examines this very link in his December 2015 paper Risk Preferences and Misconduct: Evidence from Politicians, and delivers some intriguing results.

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

“Risk-taking is widely understood to be a vital aspect of leadership, as it can generate immense value. Entrepreneurs, who are famous (or infamous) for their risk-taking qualities, are vital for economic growth; Schumpeter (1942) would go so far as to say that they are “essential to capitalism” (Hathaway and Litan [2014]).

In politics, politicians seeking to spark positive change through new or updated policy are often risk-takers. As John W. Gardner, former Secretary of Health, Education, and Welfare under President Lyndon Johnson, so ostentatiously stated: “What leaders have to remember is that somewhere under the somnolent surface is the creature that builds civilizations, the dreamer of dreams, the risk taker.”

But risk-taking can also eradicate value. The Great Recession is replete with examples of risk-taking destroying value, often through misconduct. This paper asks a simple question: might those who have a greater appetite for risk be more likely to cause harm through misconduct? Our research finds an affirmative answer.

Although risk-taking and misconduct occurs in many settings, one setting that provides an excellent laboratory in which to explore the potential link between risk preferences and misconduct is politicians. Due to the highly public lives that politicians lead, misconduct is common and observable, as is risk-taking. As a motivating example, consider former U.S. Representative Tom Delay, who engaged in some risk-taking in the 1970s. He became an entrepreneur after his graduation from college and drastically increased the value of the pest control firm he purchased. He used his success as a springboard into politics where, amidst myriad other scandals, he was ultimately convicted of money-laundering.1 Consider Hillary Clinton’s history as another example: in 1978, she engaged in some highly speculative commodities investment trading, and ended up turning $1,000 into an impressive $100,000 over the course of only ten months. However, she was later involved in a plethora of scandals: from the Whitewater scandal to the mass termination of White House Travel Office employees (“Travelgate”) to her personal email use.2

The form of risk-taking that we study is financial risk-taking. To measure propensity for financial risk-taking, we reconstruct politicians’ actual portfolio allocations between safe and risky investments. The notion that portfolio allocation choices reflect an investor’s fundamental risk preferences has been a standard assumption in finance for some time (e.g., Markowitz [1952], Merton [1969], Samuelson [1969], and Arrow [1971]).

Before engaging in regression analysis, we simply consider the asset allocation of politicians that were involved in at least one scandal versus those that were scandal-free from 2005 through 2010:

  • Those involved in at least one scandal hold an average of 64% stocks compared to those with no scandal who hold an average of 54% stocks. 
  • 28% more politicians have more than 50% of their money in stocks and these same politicians are over 100% more likely to be involved in at least one scandal.

Here, we are not controlling for potentially important factors that might influence both politicians’ portfolio choices and propensity for misconduct. To explore this further, we now turn to regression analysis:

  •  A politician with 100% stocks compared to a politician with 100% bonds has a 75% greater probability of being involved in a scandal.
  •  A politician with 100% stock has over double the odds of becoming involved in a scandal the next year than a politician with 100% bonds.

[In conclusion,] we found risk preferences to be an important antecedent of misconduct.  More broadly our results also suggest a tradeoff in choosing risk-taking leaders. Voters might seek a politician with a capacity for making significant policy changes, which often requires risk-taking. However, such a politician is more prone to misuse funds and engage in other forms misconduct.”

* * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *

The author leaves off suggesting that “future theoretical and experimental research could better inform us of these and other tradeoffs when employing risk-taking leaders.”  He might just get some of that data sooner than he thinks.

The above was sourced directly from Dylan Minor’s working paper titled “Risk Preferences and Misconduct: Evidence from Politicians” published by Harvard Business School.  The entire paper can be found here.

1.https://en.wikipedia.org/wiki/Tom_DeLay. 2.http://www.theatlantic.com/politics/archive/2015/10/tracking-the-clinton-controversiesfrom-whitewater-to-benghazi/396182/

More Like This...

See another CRM2 blog post that may be of interest to you.

CRM2: The Nexus Approach to our CRM2 Reports

Topic:
CRM2
Excerpt:
With changing securities regulations coming into effect, investment firms are now required to provide individual investors with specific additional in

More Like This...

See another Foundations & Endowments blog post that may be of interest to you.

Donor Advised Funds: An Overview

Topic:
Foundations & Endowments
Excerpt:
As we approach the end of the calendar year, taxes and charitable giving inevitably surface as ”things to do” in peoples’ minds. Here, we’d like to

More Like This...

See another Human Interest blog post that may be of interest to you.

COVID: An Uneven – and Unequal – Recovery

Topic:
Human Interest
Excerpt:
Canadians have had enough of the lockdown. Here we are 18 months after you first heard of the then mysterious Wuhan flu. Today, but for any curve ball

More Like This...

See another Inside Nexus blog post that may be of interest to you.

Walking Through Time: The History of Nexus

Topic:
Inside Nexus
Excerpt:
Bob Topp’s death last month triggered my memory “replay” button, likely as it did for many of us, whether as a long-time Nexus client, employee, or

More Like This...

See another Investments blog post that may be of interest to you.

Q&A From Our Quarterly Investment Review

Topic:
Investments
Excerpt:
Your Nexus investment team participates in many meetings where a company’s CEO or CFO presents to a group of investors. These meetings often have a

More Like This...

See another Pearls of Wisdom blog post that may be of interest to you.

“Work, Work, Work, Work, Work, Work”

Topic:
Pearls of Wisdom
Excerpt:
This has been a busy year. I’ve had lots happening on the home front (a wedding!) and lots going on at the office (too long to list!) Managing work

More Like This...

See another Tax Planning blog post that may be of interest to you.

The Great Transition – A Tax Efficient Withdrawal Strategy

Topic:
Tax Planning
Excerpt:
The change from “saver” to “spender” is what I call the great retirement transition. Figuring out how to draw on your retirement savings to meet your

More Like This...

See another Wealth Planning blog post that may be of interest to you.

Living to 100… Is 100 the New 80?

Topic:
Wealth Planning
Excerpt:
It’s a common saying that there are two certainties in life, death and taxes. While we have a pretty good idea when we get taxed, which feels like all

On a Side Note…

See another CRM2 Nexus Notes Quarterly article that may be of interest to you.

No posts found.

On a Side Note…

See another Foundations & Endowments Nexus Notes Quarterly article that may be of interest to you.

Donor Advised Funds: An Overview

Topic:
Foundations & Endowments
Excerpt:
As we approach the end of the calendar year, taxes and charitable giving inevitably surface as ”things to do” in peoples’ minds. Here, we’d like to

On a Side Note…

See another Human Interest Nexus Notes Quarterly article that may be of interest to you.

COVID: An Uneven – and Unequal – Recovery

Topic:
Human Interest
Excerpt:
Canadians have had enough of the lockdown. Here we are 18 months after you first heard of the then mysterious Wuhan flu. Today, but for any curve ball

On a Side Note…

See another Inside Nexus Nexus Notes Quarterly article that may be of interest to you.

Walking Through Time: The History of Nexus

Topic:
Inside Nexus
Excerpt:
Bob Topp’s death last month triggered my memory “replay” button, likely as it did for many of us, whether as a long-time Nexus client, employee, or

On a Side Note…

See another Investments Nexus Notes Quarterly article that may be of interest to you.

The Future of Money: a Digital Currency Primer

Topic:
Investments
Excerpt:
As a bottom-up investment management firm, we spend a lot of time looking at specific companies. But keeping an eye on evolving industry trends can be

On a Side Note…

See another Pearls of Wisdom Nexus Notes Quarterly article that may be of interest to you.

A Table for None, Please; Working From Home on the Rise

Topic:
Pearls of Wisdom
Excerpt:
Reading is one of the principal occupations in our profession. As we digest a wide range of material, interesting ideas and surprising facts – some

On a Side Note…

See another Tax Planning Nexus Notes Quarterly article that may be of interest to you.

The Great Transition – A Tax Efficient Withdrawal Strategy

Topic:
Tax Planning
Excerpt:
The change from “saver” to “spender” is what I call the great retirement transition. Figuring out how to draw on your retirement savings to meet your

On a Side Note…

See another Wealth Planning Nexus Notes Quarterly article that may be of interest to you.

Living to 100… Is 100 the New 80?

Topic:
Wealth Planning
Excerpt:
It’s a common saying that there are two certainties in life, death and taxes. While we have a pretty good idea when we get taxed, which feels like all