Probing the correlation between a company's political ideology and its loan terms
When a bank lends money to a company, it determines the terms of the loan by predicting how likely the business is to repay its debt on time. To make that assessment, the bank considers the value of the company’s assets, how much it owes to other creditors and the odds that business conditions will remain favorable to the enterprise. These factors all play into the size, maturity and fees of the loan contract the bank will ultimately offer.
However, as shown in new research from Jason Na, PhD, assistant professor of finance and economics, banks also consider another surprising factor when assessing creditworthiness: political ideology. His recent paper, “Does corporate political party ideology matter? Evidence from bank loan contracts” (Review of Accounting and Finance, 2021), fills an important gap in the literature by exploring the perception of this issue from the lender side.1 “Despite the fact that top managers’ political party ideologies can affect the corporate financial policies, and bank loan contracting is one of the most frequent funding channels,” the paper notes, “it is yet to be studied how banks view the specific political party ideologies of the borrowing companies for bank loan contracts.”
Dr. Na started with a simple hypothesis. “I wondered if corporations with a Republican culture would be less likely to have loan failures or violate loan contracts because they would be more likely to espouse conservative ideologies and policies than Democratic-oriented managers,” he recalls. “If so, you would expect to see banks charging those companies lower loan fees in the bank loan contracts they offer.”
To test his hypothesis, Dr. Na first surveyed the political views of a pool of companies’ top executives. “These are the people who impact the corporation’s ethical culture; provide guidance for employee behavior; and shape business operations that affect capital structure, investment decisions and risk management,” he explained, “all of which can influence a company’s ability to pay its debt.” Next, he calculated the difference between companies’ financial contributions to the Republican and Democratic parties, divided by the total contributions to both parties during an election cycle. He then combined this figure with the political preferences ofthe residents in the state of the company’s corporate headquarters to produce a Political Culture Index (PCI) score on a scale of zero to six, with six being the most Republican.
When he compared the PCI scores of various companies to the terms of their bank loan contracts, Dr. Na found a strong correlation. “I saw that banks favor Republican-leaning corporate policies by allowing such borrowers to pay lower fees for bank loans,” he said. “This implies that banks perceive these corporations to be high-quality borrowers with less risky projects, resulting in a low rate of loan violations. Banks are recognizing the stability of these companies’ cash flows and lower equity volatility, leading to more favorable loan conditions.”
These findings, Dr. Na argues, have important implications for investors and other stakeholders, particularly if the company has a high level of debt in its capital structure. A more liberal-leaning company may have a much harder time raising capital while in debt because banks will perceive its existing debt as high risk. The findings also reveal the motivations behind some companies’ contributions to political parties: Executives may be looking to increase their ability to secure future loans on optimal terms.
This research continues Dr. Na’s long-standing interest in analyzing corporate finance, banking and financial institutions, and corporate innovation. He is now looking into the link between political ideology and other aspects of business operations. “For my next project,” he said, “I am exploring how political views may impact a company’s commitment to innovation.”
1 Na, HyunJun. “Does corporate political party ideology matter? Evidence from bank loan contracts.” Review of Accounting and Finance, vol. 20, iss. 2, 9 September 2021.