Asset Allocation and…Political Misconduct?

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.

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“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.”

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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.