Abnormal Returns from the Common Stock Investments of the U.S. Senate

Alan J. Ziobrowski,

Ping Cheng,

James W. Boyd, and

Brigitte J. Ziobrowski*

JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS I VOL. 39, NO. 4, DECEMBER 2004

Abstract

The actions of the federal government can have a profound impact on financial markets. As prominent participants in the government decision making process, U.S. Senators are likely to have knowledge of forthcoming government actions before the information becomes public. This could provide them with an informational advantage over other investors. We test for abnormal returns from the common stock investments of members of the U.S. Senate during the period 1993-1998. We document that a portfolio that mimics the purchases of U.S. Senators beats the market by 85 basis points per month, while a portfolio that mimics the sales of Senators lags the market by 12 basis points per month. The large difference in the returns of stocks bought and sold (nearly one percentage point per month) is economically large and reliably positive.

I. Introduction

Decisions made by the federal government often have serious implications for corporate profitability and are therefore of keen interest to the financial markets. U.S. Senators are among the most important participants in that decision process by virtue of their role as lawmakers and overseers of most federal agencies. Senators may also be embedded in social networks that provide them with access to valuable information. As such, Senators might be able to capitalize on this superior information through stock trading. Yet, despite their access to special information, neither federal law nor The Senate Code of Official Conduct places any unusual restrictions on the Senators’ common stock transactions. Ac- cording to the U.S.Senate Ethics Manual, “The strong presumption would be that the Member was working for legislation because of the public interest and the needs of his constituents and that his own financial interest was only incidentally related . . . .

However, public choice theory (see Buchanan and Tollison (1984)) suggests that such a presumption is unrealistic. That people act to maximize their personal utility in their public capacities as well as their private lives is the most fundamental principle of public choice theory. Thus, voters can be expected to make choices that they anticipate will maximize benefits to them personally or minimize costs. Of more relevance to this study, their elected government officials can be expected to behave likewise. As an example, it is well documented that as a member of Congress in the 1940s and 1950s, Lyndon B. Johnson frequently used his political influence at the Federal Communication Commission to obtain licenses for his radio and television stations and to block competition from invading his markets in Texas. Johnson’s influence allowed him to ultimately grow an initial investment of $17,500 into a multi-media company worth millions.

There is no academic literature dealing with Congressional common stock returns. The only related literature is Boller (1995), who investigated a random sample of Congressional delegates (both Senators and Members of the U.S. House of Representatives) and found that 75% of them invested in companies that could be directly affected by ongoing legislative activity. However, this result merely suggests a potential conflict of interest. His research did not demonstrate that these investments yielded unusually large returns.

Our goal in this research is to determine if the Senators’ investments tend to outperform the overall market. Such a finding would support the notion that Senators use their informational advantage for personal gain. We test whether the common stocks purchased and sold by U.S. Senators exhibit abnormal returns. Assuming returns are truly “incidental,” we hypothesize that U.S. Senators should not earn statistically significant positive abnormal returns on their common stock acquisitions (the null). Rejection of the null, i.e., a finding of statistically significant positive abnormal returns, would suggest that Senators are trading stock based on information that is unavailable to the public, thereby using their unique position to increase their personal wealth.

Federal law requires all Senators to disclose their common stock transactions annually in a Financial Disclosure Report (FDR). We use an event study methodology to measure abnormal returns for common stock acquisitions and sales re- ported by the Senators in their PDRs during the period 1993 through 1998. The trigger events in our study are the stock purchases and sales made by the Senators. Since these transactions were not publicly reported until long after they occurred (anywhere from five to 17 months later), the subsequent returns of these stocks could not have been market reactions to the actual transactions themselves. Any statistically significant abnormal retums therefore would likely be the result of re- actions to events anticipated by Senators and which motivated their transactions.

We find that the behavior of common stocks purchased and sold by Senators indicates that Senators trade with a substantial informational advantage. Using the calendar-time portfolio approach with the Fama-French three-factor model and the Capital Asset Pricing Model (CAPM), a portfolio that mimics the purchases of U.S. Senators on a trade-weighted basis outperforms the market by 85 basis points per month, while a portfolio that mimics the sales of Senators underperforms the market by 12 basis points per month. For Senate stock purchase transactions, the abnormal retums are both economically large and statistically significant. When measuring cumulative daily abnormal retums we find that the cumulative daily abnormal return from common stocks purchased by Senators is more than 25% during the 12 calendar months immediately following acquisition. Common stocks sold by Senators exhibit slightly positive cumulative abnormal returns throughout the year following the sale. But during the 12 months prior to sale, the cumulative daily abnonnal return is also over 25%, peaking close to the time of sale.

We also analyze the data for several subsamples to examine the sensitivity of the results to the Senators’ party affiliation and seniority. When transactions made by the Senators are separated by political party, we find no statistically significant differences between the abnormal returns of Democrats and Republicans. However, seniority is a significant factor. The common stock investments of Senators with the least seniority (serving less than seven years) outperform the investments of the most senior Senators (serving more than 16 years) by a statistically significant margin.

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