The risk taken in a politician’s private investment portfolio is a strong indicator of whether that person will cross legal or ethical lines in office.
The riskier the portfolio, the more likely the lawmaker will be involved in at least one scandal, according to new research by Harvard Business School’s Dylan Minor, visiting assistant professor in the Strategy unit.
But before you rise up tall in the saddle against politicians, consider another of Minor’s findings: The connection between risk taking and corruption is likely to apply just as well in many types of leadership roles—CEOs, say.
“If you are more of a risk taker, all things being equal, you are going to be more likely to engage in misconduct,” Minor says.
"If you are more of a risk taker, all things being equal, you are going to be more likely to engage in misconduct"
In Risk Preferences and Misconduct: Evidence from Politicians, Minor analyzes whether risk preference is a good predictor of misconduct, using members of Congress as his subjects. He delved into the politicians’ financial records, determining what percentage of their portfolios was allocated to riskier investments–in this case stocks—versus safer bonds, a standard measurement used by investment firms. He then matched the data against instances of wrongdoing covering a six-year period.
The more the portfolio balance tipped toward stocks, the greater the chance of trouble. Scandal-marred politicians on average held 64 percent stocks, versus 54 percent stocks for the scandal free. Split another way, politicians holding more than 50 percent stocks were almost twice as likely to be involved in a scandal compared to their more risk averse counterparts.
Personal investments that trend risky may be a sign that a politician will commit at least one misdeed. Source: Sam Howzit/CC by 2.0
“Going into it I had no idea if I was actually going to find the relationship as strong as it was,” Minor says.
Once Minor decided to study risk preference and misconduct, picking a “real world” setting didn’t take long.
“I needed something where we could look at portfolios because that’s a natural way to measure risk, and then we needed an area where we could actually observe some scandals and misconduct happening,” Minor says. “Hmm, where could that be? Politicians! It turns out they have a rich history of scandal in the US and elsewhere.
Federal reporting requirements for US senators and representatives mandate the disclosure of all financial transactions in a given year, which allowed Minor to construct their risk preferences. Coupled with no shortage of examples of misconduct, politicians made ideal lab rats.
Take, for example, former Texas congressman and House Majority Leader Tom DeLay. DeLay had a slew of scandals around 2005, charged with violating campaign finance laws and linked to lobbying improprieties, resulting in his 2006 resignation from office. He was later prosecuted on money laundering charges for actions occurring while he was in Congress. DeLay’s portfolio between 2004 and 2006 was allocated 100 percent to stocks, Minor says.
Lessons for the boardroom
The implications extend beyond the Senate or House floor to the boardroom. “Whether it’s entrepreneurship or traditional management, to improve the performance of the organization we actually want to have a leader that’s less risk averse … willing to take on these risks to innovate,” Minor says.
Maybe there’s a tradeoff here to consider, he continues. “As you get someone who’s much more willing to take risks, it turns out they’re also more willing to take advantage of the company or engage in some type of misconduct. That could to an extent temper how much of a risk taker you want if you care about the misconduct part.”
Companies already use data analytics to flag workers who are job-hoppers and take steps to retain them. Minor envisions companies setting up similar red flags for financial risk taking, which could trigger greater surveillance. For investment brokers and advisors, certain transactions raise a red flag, but personal character traits do not.
Some social psychologists tend to view risk preference not as a stable characteristic but as a result of circumstance and situation. Minor disagrees.
“That’s the distinction I was trying to make here--that it is some type of individual characteristic that will predict not only productivity and some of these other behaviors, but also the likelihood of misconduct,” Minor says.
Tracking down misconduct
Minor is no stranger to the topic of risk preference. Before entering academia he launched his own investment firm. He constructed lawmakers’ risk preferences using data compiled by the Center for Responsive Politics, which tracks issues related to money and politics and operates OpenSecrets.org.
Direct stock or bond holdings were straightforward to categorize as risky or not. For mutual funds Minor tapped investment industry experts to help him devise an algorithm to categorize the 10,000-plus funds as more weighted toward stocks or bonds.
The typical result for members of Congress was roughly a 60-40 split, with 60 percent allocated in stocks and 40 percent in bonds. That’s a classic portfolio for investors of the same age, which Minor says helped confirm he was on the right track.
The misconduct data took more effort to gather. He turned to a nonprofit called Citizens for Responsibility and Ethics in Washington (CREW), which assembles information from court records and other sources to create an aggregate data set of members of Congress involved in a scandal. Minor studied incidents occurring between 2005 to 2010.
Minor expected the bulk of misconduct would be sexual escapades and the like, but his research proved this hypothesis wrong. Roughly 72 percent were financial scandals, with the misuse of campaign funds a recurring theme.
“Most of it is very simple; they’re just stealing,” Minor says. “It also links it more closely to the boardroom and business in that it’s just old-fashioned stealing money from the organization.”
After colleagues questioned whether he was measuring risk preference or another characteristic like greed, Minor added a second part to his research. He called on wealthy investors at an unnamed investment firm, with an average $700,000 portfolio and demographics similar to the politicians.
The investors were sent a one-page survey billed as a fun economics game that would have no bearing on their portfolios, with gift certificates as a reward. They were given a series of options, starting with a choice between a 10 percent chance of $60 and a 90 percent chance of $50; or a 10 percent chance of $120 and a 90 percent chance of $5. The odds shifted slowly in each subsequent row, allowing Minor to see how much assurance of a bigger payoff investors needed before making the riskier choice.
“The idea is the longer it takes you to switch, the more conservative you are. This is a standard risk elicitation method that’s been used in the laboratory countless times now,” Minor says. He then compared the survey results to the investors’ actual portfolio choices. What he found was striking.
“Their small scale choices of $50 or $60 actually did a really good job in predicting their choice in the high-stakes setting,” Minor says. “It just convinced me more that yes, when you look at the portfolio and investment choices of people, you really are seeming to capture some stable, individual characteristic.”
Race for president
Re-entering the political sphere, Minor’s research begs the question of how this could apply to the current presidential race. The paper does not make claims in this regard, but Minor says the two-front running candidates have already been associated with financial risk-taking and scandal.
“Hillary obviously already has [been associated with] scandals, and I know Donald Trump has as well. So unfortunately they’re both predicted to be scandalous.”